Investment markets were mixed in November, with both gains and losses recorded across major share markets.
For the month of November, the All Ordinaries Index declined by 1.3% to close at 5,218.2 points. The US Dow Jones Index gained by 0.3% the London FTSE declined by 0.1%, the Japan Nikkei 225 Index gained by 5.0% and the Hong Kong Hang Seng Index declined by 2.8% in November.
All attention over the coming weeks will be on the US Federal Reserve (the "Fed") meeting on 15/16 December. With US unemployment having halved to 5.0% over the past six years, and US inflation likely to rise, a rate increase seems well justified.
Increases in official US interest rates have historically led to increased sharemarket volatility (with six of the past seven cycles recording a decline in the first year). However, very few of the rate hike cycle have triggered the end of the equity bull market (with six of the seven cycles recording price gains over +25% in the subsequent three years).
The chart below shows the returns of the US sharemarket following an increase in official US interest rates.
As noted in the above chart, the price gains after the first year decline reflect the fact that the Fed raised interest rates because the economy was strengthening (and this underpins a rise in earnings growth, which also fuels higher share dividends).
This does not mean that market corrections will not happen. The 1999/00 and 2004/06 cycles preceded two of the largest US sharemarket declines in the past century. However, those declines were not driven by restrictive US monetary policy, rather by external shocks such as the bursting of the dotcom boom and the Global Financial Crisis.
While no two Fed rate rising interest rate cycles (or set of economic conditions) are identical, valuations at the start of any tightening cycle are notable determinants of future investment returns. In this regard 2016 will start with valuations more stretched than has traditionally been the case over the past four decades.
The Fed will not intentionally endanger the recovery and will continue to have the words 'cautious', 'patient' and 'gradual' in its market guidance to calm investors. In this way, the rate hike start date doesn't matter – it is the pace and nature of the tightening cycle that will determine the market's reaction. As such, the date of the second rate hike is probably more important than the first.
In domestic interest rate news, the Reserve Bank kept the official Cash Rate on hold at 2.00% per annum in its meeting today. The Australian Dollar strengthened marginally in the month, with 1 Australian Dollar currently buying 72.31 US cents.
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This article is general information only and is not intended to be a recommendation. We strongly recommend you seek advice from your financial adviser as to whether this information is appropriate to your needs, financial situation and investment objectives.