Fed Hike Could Send Stocks Plummeting This Week

The Federal Reserve is likely to raise interest rates by a quarter point on Wednesday, according to market pricing. Goldman Sachs strategists led by Ben Snider warn that this could weigh on stocks due to uncertainty about the duration and magnitude of tightening.

The S&P 500 has historically averaged a negative 2% return during the first three months of Fed hiking cycles. This is partly because high-valuation, highly concentrated bull markets have previously coincided with the peak of hiking cycles, and AI-related companies dominate the current market.

AI introduces another vulnerability: its boom is unusually sensitive to the cost of money due to extraordinary capital spending required for data centers, chips, power generation, and other investments. Goldman estimates that a company would need to increase its expected long-term growth rate by two percentage points to fully offset a one-percentage-point increase in its cost of capital.

The S&P 500's forward price-to-earnings ratio has fallen from roughly 22 times at the beginning of the year to 19 times, but earnings growth rather than further multiple expansion has driven stock prices higher. The immediate risk is that Wednesday changes the question Wall Street has been asking: whether the Fed will actually resume tightening.