What works best after the Fed pauses rate hikes

Published Mon, May 15 202312:30 PM EDTUpdated Mon, May 15 20231:05 PM EDT

With the Federal Reserve expected to pause rate hikes in the near future, investors may want to look at what has worked well during past pauses. According to Trivariate Research's Adam Parker, that is emerging markets, technology stocks and real estate. The central bank, which has been increasing interest rates to combat inflation, hinted earlier this month its tightening cycle may be at its end. To evaluate the asset classes and sectors that should rally off the policy shift, Parker looked at 50 years of fed fund rates and identified periods where the central bank paused. From there, he looked at the performances of the major asset classes in the three months following Fed pauses since 1986. "On average, equities did better than bonds. EM equities were best, followed by European and then US equities. High-yield bonds performed the worst," said Parker, who spent several years at Morgan Stanley as its chief U.S. equity strategist and global director of quantitative research. Since higher interest rates increase the value of the U.S. dollar, making it more difficult for emerging markets to pay their dollar-denominated debt, it makes sense a pause in hikes will benefit the asset class. Investors looking to play emerging markets can look at the iShares MSCI Emerging Markets ETF . The exchange-traded fund lost more than 22% last year and is up about 3% so far this year. U.S. equities Within U.S. equities, technology was the winner. Parker looked at the sector returns over the last five Fed pauses where there was data readily available. Real estate investment trusts were evaluated on two criteria due to data limitations. Tech stocks were crushed last year as the Fed raised interest rates, with the Technology Select Sector SPDR Fund (XLK) losing more than 28% in 2022. Higher rates typically result in less attractive valuations for tech stocks since their future profits become less valuable. However, tech has rebounded this year, especially the large-cap names. The XLK is up 21%, while the Invesco QQQ Trust , which tracks the Nasdaq 100 , is up 22%. Parker currently has an equal weight rating on the sector. REITs have also been hard hit by interest rate hikes as the cost of borrowing increased and investors searching for yield may have dumped the asset in favor of risk-free Treasurys. To play a potential rebound in the sector, investors can look at the Real Estate Select Sector SPDR Fund . The fund lost nearly 29% in 2022 and is just up fractionally so far this year. — CNBC's Michael Bloom contributed reporting.