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Multiple Movement

I frequently hear investment strategists say that there will be no P/E, or multiple, expansion in 2015 while Wall Street awaits the start of a new rate tightening cycle, possibly as early as June. Yet history says the opposite. After examining the 16 times since 1946 that the Federal Reserve started a rate tightening program, the median multiple on trailing 12-month GAAP (or “As Reported”) EPS rose from 17.7X six months before to 17.9X three months before and 18.5X on the date of the first rate increase. Only in the three and six months after the Fed started raising rates did the P/E median decline to 18.1X and 16.7X, respectively.

Leading up to the first rate hike, the S&P 500 and its 10 sectors appeared to take this eventuality in stride. Since 1946, the S&P 500 rose a median 8.2% and 3.9% in the six and three months leading up to the first hike, posting only three declines in each timeframe. Three months after the first rate increase, however, market returns exhibited much more uncertainty as the S&P 500 recorded a median decline of 1.5% and fell in price 11 of 16 times. Six months after, things began to simmer down as the S&P 500 fell six times yet recorded a median advance of 4.8%. From a sector perspective, all 10 recorded average increases in total returns within six months of the first rate hike since 1971, led by Energy (+16.1%), Industrials (+11.5%) and Info Tech (+11.3%) versus a 9.9% gain for the S&P 500. The worst performances were recorded by Health Care (+7.8%) and the higher-yielding Telecom Services (+7.8%), and Utilities (+4.1%) groups.

So there you have it. Contrary to most strategists’ opinions, the S&P 500 saw P/E expansion leading up to the first rate hike. Also, the market and its sectors recorded enviable returns within six months of a new rate-tightening cycle. This time, while there’s no guarantee we will also see multiple expansion, history shows that it is possible. The post hike period may be a different story, however, as the “500” endured two corrections and two bear markets after new rate-tightening cycles since 1946.

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