Fed rate hikes aren't always bad for stocks

— -- Q: How have stocks typically responded when the Fed starts to hike interest rates?

A: A book could be dedicated to the relationship between Federal Reserve policy and the stock market.

But, I'll spare you the detail. Usually when answering a question like this, I would go as far back in history as possible and see what happened. And, generally, what you'd find is that higher short-term interest rates have often been bad for stocks. But that's not always the case.

To answer this question, I'm going to use a publicly available record of Federal Reserve moves that go back to 1990.

First, you'll want to open a Web page that shows the Fed's changes to the intended federal funds rate back to 1990, which is available here.

If you read the chart from the bottom up, you see that the Fed first raised rates during this period on Feb. 4, 1994. Stocks weren't too happy with the news, and the Standard & Poor's 500 dropped 10.90 points to 469.81 that day. That hike was followed by six more and the subsequent six months weren't much better for the stock market. The S&P 500 skidded from 469.81 to as low as 438.82 on April 4 and closd out the six-month period at 458.40.

That's the bad news. The good news is that one year after the first hike, Feb. 6, 1995, the S&P 500 was 2.4% higher, at 481.14.

The Fed hiked rates again on March 25, 1997. That was a one-time hike, though, so now we'll consider the hikes that started on June 30, 1999.

That was the first in a series of six increases that ended May 16, 2000 with a target fed funds rate of 6.5%. The first increase spurred a bad reaction, with the S&P 500 sliding 1.82 points to 789.07. But the situation six months later was totally different. The S&P 500 soared, jumping to 937.91. And a year later? Stocks went on an absolute tear, jumping to 1101.93 on March 25, 1998. So much for interest rate hikes being bad for stocks.

The next period of hikes started on June 30, 2004 — and this one lasted quite a while. Rates were cut an additional 16 times through June 29, 2006. Let's look at the videotape. On the day of the first cut, the S&P 500 actually rose 4.64 points to 1140.84. Six months later, again, stocks jumped with the S&P 500 closing at 1213.55 on Dec. 30, 2004. And a year later stocks were flattish, but still held onto most of their gains to close at 1191.33 on June 30, 2005.

As you can see, recently at least, higher short-term interest rates haven't been as poisonous to stocks as widely believed. It's impossible to know ahead of time whether stocks will react as well if the Fed begins to boost rates in 2008 or 2009 to curb inflation. But the recent history at least gives you some perspective once higher rates do arrive.

Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at mkrantz@usatoday.com. Click here to see previous Ask Matt columns.