The Fed raised interest rates for the first time in more than three years on Wednesday, and the market didn’t seem to mind.
That’s probably because the move – a quarter-point hike that raised the federal funds rate from a range of 3.50-3.75% to a range of 3.75-4.00% – had been telegraphed for weeks, with 92.5% of economists anticipating the move as of Wednesday morning, and north of 60% of economists expecting it for at least a week, according to the CME Group’s FedWatch Tool. So, the rate hike was likely somewhat “baked in” to the current market, as they say. It’s the $100 oil prices, sky-high bond yields and the possibility that AI could kill us all that are keeping investors up at night more than Kevin Warsh and the Fed these days.
Of course, this week’s rate hike – designed to bring down rising inflation due in large part to the ongoing Iran war and the impact of tariffs – may help to dampen bond yields as a byproduct. Regardless, rate hiking cycles are ultimately good for the market, even if it doesn’t often look like it at the beginning of the cycle.
Fed Rate Hikes: Short-Term Pain, Intermediate-Term Gain
Prior to Wednesday, the Fed had started raising rates seven times since 1988. On average, the S&P 500 has fallen 4% in the six weeks that followed the first rate hike, according to data compiled by The Kobeisi Letter. In every case, stocks recovered all those first-six-weeks losses in the ensuing five to six weeks and gained an average of 9% in the 12 months that followed the initial hike. Thus, rate hiking is a lot like giving a sick child medicine: they’ll resist and hate the taste at first, but eventually … it will cure them.
Indeed, inflation – at 3.4%, well above the Fed’s 2% target, as it has been for five years now – remains a problem. It looked like it was fading, on the brink of reaching that 2% target – it dipped to 2.4% as recently as this February. And then … the Iran war happened, sending oil and gas prices skyrocketing and, more indirectly, raising the prices of things like fertilizer, wheat, corn, beef, etc.
If the war ends today, chances are prices will start to come down dramatically. In fact, we saw it with oil and gas prices in June and July, when an extended ceasefire was put in place and the war was effectively declared “over” … quite prematurely, as it turned out. (Although it certainly doesn’t sound like this will be the only rate hike, regardless of what happens with the war.)
Bottom line: Everything is still in flux, even after Wednesday’s rate hike. And the best we can do as individual investors is try to tune out the overwhelming number of headlines and invest based on the evidence of the market and the charts of the stocks we follow. Indeed, the market has held up fairly well considering the myriad existential crises threatening to derail it. So far, this looks like a normal, orderly September pullback – the kind we get almost every year, regardless of what’s happening in the world.
And value stocks continue to outperform, up 15.5% year to date versus a 10.8% YTD gain in the S&P, an 11.8% return in the growth- and AI-heavy Nasdaq, and a mere 8.4% run-up in the Dow Jones Industrial Average. Granted, value stocks have pulled back somewhat in the last month too … but not as much as the three major indexes.
In fact, in the last month I have closed out two positions in my Cabot Value Investor portfolio that reached our price target, both for double-digit returns. To learn what value stocks I’m currently recommending, you can take out a subscription to Cabot Value Investor by clicking here.
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