The Fed is set to hike interest rates in 2022. Here's what that means for US stocks.
- The Federal Reserve is set to start hiking interest rates next year as it tries to tackle sky-high inflation.
- History shows that on average, the S&P 500 has risen in the 12 months after the first rate-hike of a cycle.
US stocks had a banner year in 2021.
The Federal Reserve held interest rates low and pumped more than $1 trillion into the economy, and growth rebounded after the slump of 2020. The benchmark S&P 500 stock index duly soared.
But sky-high inflation has caused the Fed to sharply scale back its bond purchases, and eye up a number of interest-rate rises next year.
Markets expect the central bank to start hiking in either March or May, given it signaled that it's likely to raise rates three times in 2022.
Rate hikes aren't bad for stocks
So is the end of easy money bad news for stocks? History says no.
Over the last 30 years, the Fed has embarked on a rate-hiking cycle four times, according to FactSet figures shared with Insider. The data company defines a cycle as a run of four rate increases, made at no more than six-month intervals.
On average, the S&P 500 has moved 1.8% lower in the three months after the first hike. But it has then gained to stand 4.6% higher after six months, and 7.7% higher after 12 months.
"Rising rates alone aren't bad for stocks," Bank of America strategist Savita Subramanian said in a note.
Yet history may not always be the best guide. After all, stocks rose 6% in the year after the Fed started hiking rates in 1999, only for the S&P 500 to plunge dramatically in 2000 as the dotcom bubble burst.
The outlook is unusually uncertain, and analysts are divided about what might happen over the next year.
BMO's Brian Belski reckons the S&P 500 will surge to 5,300 by the end of 2022, as the recovery continues and Fed policy remains supportive, by historical standards.
But Morgan Stanley thinks it'll be much lower, at 4,400.
Tech stocks could struggle
Analysts say the uncertainty — such as around inflation, coronavirus variants, the pace of rate rises, US midterm elections — means investors have to think harder about which stocks can thrive.
The prospect of higher rates has hit tech stocks, particularly unprofitable ones, over the last month. The future earning potential of techs is usually exciting, but looks less attractive when there are higher yields to be had elsewhere.
US inflation is expected to remain elevated for much of 2022. That could further hurt many tech stocks, by pushing investors toward other companies with solid dividends or that can pass costs on to customers, analysts said.
"Our core [picks] are sectors that should benefit from further economic expansion into 2022, stabilizing China activity, and have earnings/pricing power to defend their valuations against potentially higher rates volatility," said Emmanuel Cau, equity strategist at Barclays, in a note.
Barclays likes the look of the energy, industrials and healthcare sectors.
Brace for more volatility
Investors are preparing for a rougher time in 2022, compared with the relative calm of 2021, as growth rates cool and inflation remains elevated.
Steen Jakobsen, chief investment officer at Saxo Bank, told Insider he thinks there's a 25% chance that the Fed lets inflation get out of control and has to hike rates faster than investors expect, in what is called a policy mistake. "Then we get a full-blown sell-off in the market," he said.
Wall Street analysts on average expect the S&P 500 to end 2022 at 4,843, according to a November poll by Bloomberg.
But they agree that it's unlikely to be a smooth ride. "Volatility is likely to increase precipitously over the next 12 months," said BofA's Subramanian.