LPL: How Stocks performed Historically After Initial Fed Rate Hikes?

What History Tells Us About Stocks After a Fed Rate Hike

The Federal Reserve raised interest rates by a quarter percentage point in September, putting renewed attention on what higher rates could mean for the stock market.

While every economic cycle is different, history can provide some perspective on how equities have behaved following the beginning of previous Federal Reserve tightening cycles.

The First Few Months Can Be Bumpy

Looking back at six Federal Reserve tightening cycles since 1994, the S&P 500 has often experienced some short-term weakness after the first rate increase.

Historically, stocks tended to struggle during the first several months following an initial hike. On average, returns remained negative through approximately the first four months before improving around the five- to six-month mark.

That pattern is worth noting because an interest-rate increase can initially create uncertainty for investors. Higher borrowing costs can affect businesses, consumers, corporate profits and market valuations.

However, short-term volatility hasn’t necessarily translated into poor longer-term stock performance.

The 12-Month Picture Has Often Been Stronger

Across the six tightening cycles examined, the S&P 500 produced an average 12-month return of approximately 6.7% following the initial rate increase. The median return was even higher, at approximately 10.7%.

Those averages include very different economic environments, which illustrates an important point: interest rates are only one factor influencing market performance.

Economic growth, inflation, employment, corporate earnings and investor expectations can all play significant roles in determining how stocks respond.

Not Every Rate-Hike Cycle Looks the Same

Two historical periods demonstrate just how different the market’s reaction can be.

In 2022, stocks faced a particularly difficult environment as inflation surged and the Federal Reserve aggressively raised interest rates. The S&P 500 experienced significant declines as investors weighed sharply higher borrowing costs and growing concerns about a potential recession.

The late 1990s presented a much different story.

Following an initial rate increase in 1997, stocks continued climbing amid strong economic growth and enthusiasm surrounding emerging internet technology. The S&P 500 ultimately posted a substantial gain during the following 12 months.

Neither period provides a perfect roadmap for today’s market, but together they demonstrate why the economic environment surrounding a rate increase matters.

Economic Fundamentals Remain Important

A Federal Reserve rate hike doesn’t automatically signal trouble for stocks.

Historically, markets have been better able to absorb higher rates when economic growth remained healthy and recession risks stayed contained. Conversely, tighter monetary policy can create greater challenges when higher rates coincide with deteriorating economic conditions.

For investors, this means the direction of interest rates is only part of the picture.

Employment trends, inflation, economic growth, corporate earnings and consumer activity may provide important clues about whether businesses and households can continue adapting to higher borrowing costs.

Keeping Rate Moves in Perspective

Periods surrounding Federal Reserve decisions can create additional market volatility, especially as investors adjust expectations about inflation and future monetary policy.

History suggests that stocks may experience some turbulence following an initial rate increase, but past tightening cycles have also shown that markets can regain their footing as investors turn their attention back toward economic growth and corporate fundamentals.

Rather than reacting to a single Federal Reserve decision, investors may benefit from keeping interest-rate changes within the context of their broader financial goals, investment strategy and time horizon.

Past performance does not guarantee future results, and every market cycle presents its own set of opportunities and risks.

SOURCE: https://www.lpl.com/research/blog/how-stocks-performed-historically-after-initial-fed-rate-hikes.html