Lessons From 1994’s Rate Hikes Offer Little Comfort

Who says history doesn’t repeat? The Federal Reserve today is expected to raise the target for its benchmark short-term interest rate by half a percentage point--six years to the day of the first half-point hike in the Fed’s last major credit-tightening round.

But whether financial markets’ reaction to the Fed’s more aggressive stance in 1994 can tell us anything about what might occur this time around is questionable.

When the central bank began a series of rate increases in 1994 to slow the economy, it started with quarter-point moves--just as the current round of rate increases, which began in June, has entailed only quarter-point moves.

After raising the so-called federal funds rate by a quarter point Feb. 4, March 22 and April 18, 1994, the Fed on May 17 of that year opted for a half-point increase to 4.25%.

This time, the Fed already has made five quarter-point moves, the last of which was March 21, when the fed funds rate was lifted to 6%.

What Wall Street fears is that the Fed is far from done. And the 1994 experience offers little comfort: After the May increase, the Fed raised its key rate another half point Aug. 16, then a whopping three-quarters of a point Nov. 15, to 5.5%.

In other words, the Fed’s “gradualist” approach ended May 17, 1994. Worried about the then-strong economy and a modest uptick in inflation, the Fed was much more aggressive with the following two rate increases than many investors expected.

Wall Street’s shock at the time, however, was largely reflected by the bond market: The yield on the two-year U.S. Treasury note rocketed from 5.8% at the time of the May 1994 Fed rate hike to more than 7.7% by year’s end, as bond investors initially underestimated the Fed, then panicked.

Yet the stock market held up relatively well in 1994. For the year, the Dow Jones industrials actually inched up 2.1%.

Now, however, stocks are valued at far higher prices, relative to underlying earnings, than they were in 1994. That may mean the stock market overall is much more vulnerable to being hurt if investors again underestimate what the Fed has planned for rates.

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Fund Stocks Get a Lift

The surprise takeover deal by Italy’s UniCredito Italiano for U.S. mutual fund company Pioneer Group set fund stocks in general soaring on Monday. But many still sell for relatively low price-to-earnings multiples (P/E), based on the most recent 12 months’ earnings per share. A sampling:

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52-wk. 52-wk. Mon. close Company (ticker symbol) low high and change P/E Franklin Resources (BEN) $24.63 $45.00 $32.13, +$1.06 15 Gabelli Asset (GBL) 14.19 22.25 22.75, +0.88 13 Neuberger Berman (NEU) 23.63 36.88 35.56, +1.06 13 Pioneer Group (PIOG) 10.00 31.50 42.06, +11.06 NM T. Rowe Price (TROW) 25.88 42.88 38.13, +5.11 16 United Asset Mgmt. (UAM) 13.75 22.88 19.88, +1.44 17 Waddell & Reed (WDR) 13.44 28.31 26.38, +0.06 25

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NM = not meaningful (loss reported for last 12 months)

Sources: Reuters, Times staff