The Federal Reserve raised its benchmark rate by 25 basis points to 3.75%-4% at its September meeting, the first increase in more than three years. History from five of the last six tightening cycles suggests stocks can still post solid gains over the following year, even after an initial pullback.
Fed lifts rates, more hikes possible
The Federal Reserve raised its target range by 25 basis points to 3.75%-4% at its September meeting, marking its first increase in more than three years as it works to fight inflation. Fed Chair Kevin Warsh wants inflation back near 2%, noting that too many categories were running above 3%. Another increase is expected by year-end, with more possible in 2027. Aside from four outliers who expect cuts in 2027, the Fed's dot plot shows most members expect rates to end that year between 4.25% and 4.5%.
History favors stocks after the first hike
The Fed's previous tightening cycle, which began in March 2022, led to a more than 25% decline in the S&P 500, with the index eventually troughing in October that year. However, the five prior rate-hike cycles since 1994 saw the S&P 500 decline only 8% to 14%, according to RBC Wealth Management. Outside the 2022 bear market, the index posted positive returns in the 12 months following an initial hike in each of the other five cycles, including a 42% gain after the March 1997 hike.
Why this cycle looks different from 2022
The 2022 cycle followed years of extremely low rates and saw the Fed raise the federal funds rate by 525 basis points, while investors feared an imminent recession. This cycle, by contrast, is expected to be shorter and milder, with the dot plot pointing to only another 25 to 50 basis points of increases.
The better comparison may be 1997, when stocks soared amid the dot-com boom; today's equivalent is the artificial intelligence supercycle. The timing also lines up with the period after midterm elections, when the S&P 500 has gained over the following 12 months 95% of the time since 1938, averaging a 14.5% return since 1950.
Analyst favors sticking to a core strategy
Past hike cycles show initial downturns tend to be short, typically bottoming a month to three and a half months later, according to Motley Fool analyst Geoffrey Seiler. He favors dollar-cost averaging into core index ETFs such as the Vanguard S&P 500 ETF and the Invesco QQQ Trust, which tracks the Nasdaq-100, rather than trying to time the market.
Source: The Motley Fool
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