The Federal Reserve is ready to raise interest rates again, with markets assigning a 90% chance of a 25-basis-point hike on Wednesday. This will mark the first increase in the federal funds rate since 2023.
A new tightening cycle typically means falling stock prices. Higher rates make borrowing more expensive, pressure valuations and offer investors a more attractive alternative to equities.
LPL Financial studied how the S&P 500 performed following the first Fed hike in six tightening cycles since 1994. The initial reaction was rarely comfortable:
- Stocks posted negative average returns during each of the first four months after the initial hike.
- After one year, the S&P 500 delivered an average return of 6.7% and a median gain of 10.7%.
- The S&P 500 surged nearly 8% during the two months following the Fed’s March 1997 hike.
- Twelve months later, it was up 42%.
“The key lesson from these prior cycles is that rate hikes do not typically derail bull markets,” LPL Financial strategist Jeff Buchbinder said in a recent note.
Is This 1997 Or 2022?
The emerging internet boom overshadowed rising borrowing costs.
“In the battle between higher interest rates and revolutionary technologies, technology can win for a while,” the strategists said.
That comparison is difficult to ignore today.
Artificial intelligence investment is driving demand for semiconductors, data centers, electricity infrastructure and cooling equipment. Rising corporate profits have helped contain recession fears.
The 2022 tightening cycle delivered the opposite result.
The broader index, tracked by the SPDR S&P 500 ETF Trust (NYSE:SPY), fell for two months after the March 2022 hike and stayed down for more than a year, enduring a 25% drawdown while the Fed tightened aggressively into multi-decade-high inflation.
LPL argues the hike was never the problem. The recession risk attached to it was.
Why The Economy Is Less Sensitive To Rates
American households have another advantage they lacked during earlier tightening cycles.
Millions of homeowners purchased properties or refinanced mortgages when interest rates were near 3%. Their monthly payments do not increase when the Fed raises rates.
Consumer debt-service payments represented 5.29% of disposable personal income in March. Mortgage debt-service payments stood at 5.88%, according to Federal Reserve data cited by LPL.
“Higher interest rates aren’t packing the punch they once did,” the strategists said.
Rising home and equity values have also strengthened household balance sheets. That wealth helps consumers absorb higher prices without immediately cutting spending.
How LPL Is Positioned Into The Hike
The firm’s Strategic and Tactical Asset Allocation Committee is keeping a tactical equity overweight and a fixed income underweight.
It favors industrials and energy, tracked by the Industrial Select Sector SPDR Fund (NYSE:XLI) and the Energy Select Sector SPDR Fund (NYSE:XLE) — industrials as a lower-beta route into the AI infrastructure buildout, energy as a hedge against further supply disruption.
The SPDR S&P 500 ETF Trust (NYSE:SPY) is up about 11% year-to-date.
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