Fed Rate Hikes May Not Be So Bad for Stocks After All

The Federal Reserve recently raised interest rates for the first time in over three years to combat inflation. The target range is now between 3.75% and 4%. This marks the start of a new tightening cycle, with another rate increase expected by year-end and potentially more in 2027.

Past Fed tightening cycles have been associated with initial stock price declines, but history suggests that these downturns are typically short-lived. In fact, outside of the 2022 bear market, the S&P 500 has produced positive returns in the 12 months following an initial rate hike in each of the other five tightening cycles since 1994.

The average 12-month S&P 500 return following an initial rate hike is 6.7%. The current Fed tightening cycle is expected to be relatively short and mild, with a maximum increase of 50 basis points from here. This cycle also coincides with the AI supercycle and takes place before the midterm elections.

The market's best performance historically comes after midterm elections, with the S&P 500 seeing gains 12 months following elections 95% of the time since 1938. The index's average return during this period is a robust 14.5% since 1950.