In 1994, there was a rate shock when Alan Greenspan recognized that the Fed was too easy given the boost in economic growth coming out of the 1990-1991 recession (Desert Storm, S&L Crisis, etc). Greenspan addressed this with a 25 basis point hike in February 1994 and then continued to push overnight rates up by a combined 225 basis points over the course of the year. Yields on the 30-Treasury jumped 175 basis points to 7.75% in the first 9 months – which helped destroy the finances of Orange County, CA, push Mexico into a financial crisis and wreak havoc across Wall Street. It became known as the Bond Market Massacre, and the stock market wasn’t immune, with a huge correction occurring that spring.
Here’s what it looked like, for the Dow Jones Industrial Average (in percentage terms from the start of that year):
* The Massacre in the bond market spilled over into the stock market as participants adjusted to the growing pains that come along with a faster economy than they had been expecting.
* Good economic news does not equal more stock gains.
* Every asset class is in a competition with every other asset class for investment dollars. When the dynamics in one asset class change (you can now earn 1.5% in a money market account, as opposed to zero), investors in the other asset classes will make changes to their portfolios. This is happening now, as REITs, Utilities and other high-yielding sectors of the equity markets see investor interest walk out the door – there are now less risky ways to earn income thanks to higher nominal interest rates on Treasurys.
* The recovery for stocks as investors grew accustomed to the new environment of faster growth / higher rates did not take long. Within a year of Greenspan’s February hike, the Dow had bottomed. Enormous stock market gains from 1995 through 1999 were on their way, though no one could have known at the time.
* All things being equal, an accelerating economy with increased wages and rising business spend is a positive for America, especially when coupled with a mirror image scenario happening in countries all over the world. But that doesn’t mean every day is a picnic for the stock market.
* We’ve grown accustomed to slow growth, low rates, high multiples. Now the game is changing.