S&P 500 Averages 10.8% Gain in Year After Fed Rate Hikes, UBS Finds

Contrary to common investor fears, the beginning of a Federal Reserve interest rate hiking cycle has historically preceded periods of equity market strength, not downturns, according to a new analysis from UBS.

Historical Performance Post-Hike

In a note to investors, UBS strategists led by David Lefkowitz examined 16 separate Fed tightening cycles dating back to 1954. The analysis revealed that the S&P 500 has performed well in the year following the initial interest rate increase.

Key findings from the report include:

• The S&P 500 rose by an average of 10.8% in the 12 months after the first hike.
• The market has never entered a bear market in the year immediately following the start of a tightening cycle in the periods studied.

UBS argued that this historical precedent should ease investor concerns ahead of the Fed's widely expected rate increase this week.

Economic Growth Outweighs Hikes

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The bank's strategists contend that underlying economic strength and earnings growth are more significant drivers of equity performance than the rate hikes themselves. They identified the new orders component of the ISM Manufacturing index as a key indicator that best explains market returns after a tightening cycle begins.

With manufacturing still in expansionary territory and investment in artificial intelligence expected to grow, UBS stated that the current economic backdrop is more consistent with continued growth than a contraction. The firm maintained its S&P 500 price targets of 8,100 for the end of the year and 8,400 for mid-2027.

Valuation and Outlook

UBS also suggested that much of the valuation adjustment from higher rates may have already occurred. The S&P 500's forward price-to-earnings multiple has compressed to approximately 19.5 from 22 at the start of the year, as the 10-year Treasury yield has climbed toward 5%.

The analysts wrote that they do not anticipate the kind of "aggressive tightening cycle that characterized several previous inflation-fighting episodes," attributing much of the current inflation to temporary factors.