The unsettling truth about why stocks rise during rate hikes
History shows that stock prices rise, even as the Federal Reserve begins a new cycle of tighter monetary policy.
But there's much more to this story.
"The lesson from the past seven tightening cycles is that equities may wobble when the Fed raises rates, but quickly recoup losses," HSBC's Ben Laidler wrote. "The key to this positive historical performance is earnings growth. Valuation multiples typically contract as the Fed tightens."
Without earnings growth, contracting valuations - as measured by the price/earnings (PE) ratio - mean stock prices will have to fall.
"It's amazing how forgiving the general commentary has been on profits and even the broad economy," Deutsche Bank's David Bianco said in an email to Business Insider."Many seem to celebrate the absence of a recession. The labor market continues to tighten ... but other than some bright spots like auto and housing, growth is extremely weak with underlying drivers like productivity and investment disturbingly poor and S&P profits are not growing."
None of this is news, particularly in the context of tighter monetary policy.
Veteran market strategist Rich Bernstein is bullish on the stock market. But he warns that rate hikes amid weak earnings is bad news stocks in the near-term.
"The Fed now risks being wrong footed, and the problem for the stock market today is the Fed is 'threatening' to raise interest rates at a time when S&P 500 earnings growth is actually negative," Bernstein wrote. "We've been concerned for many months that the recipe for the much- anticipated correction could be the Fed hiking rates when earnings growth was negative."