Stock Talk - Will Higher Interest Rates Stop the Bull Market?

Starting point is 00:00:00 Investors, higher interest rates are back in the headlines. The easy conclusion is that higher rates must be bad for stocks. But history gives us a much more interesting answer. Since 1994, the S&P 500 has averaged an 8.7% gain in the 12 months after the first Federal Reserve interest rate hike. Technology is often done even better. So the question for investors is not simply, are interest rates going up? The better question is, what is happening to earnings while rates are going up?

Starting point is 00:00:28 Today I want to put four pieces of evidence on the table. Rate hikes, earnings, the midterm election cycle, and the age of this bull market rebound. And then you can make the call yourself. Point one, rate hikes rarely end a bull market by themselves. Let's start with the chart showing the S&P 500 returns after the first Fed hike. The short-term reaction can be messy.

Starting point is 00:00:49 Since 1994, the average S&P 500 return for three months after the first hike was a negative 2.7%. When investors six months later, it averaged a positive 3.4%. And after 12 months, a positive 8.7%. That's an important distinction. The first hike often creates volatility. It doesn't usually automatically create a bare market. Look at the individual cycles.

Starting point is 00:01:15 After the March 1997 first hike, the S&P 500 gained almost 40% over the next year. And after June 1999, it still gained about 6%. Even longer history back in the 1970s shows many positive 12-month outcomes after the first Fed rate hike. The asset class chart tells the same story. Over roughly 300 trading days after the first hike, the historical path shows stocks, and especially the NASDAQ, beating treasuries. And the sector chart is even more surprising since 1994. Information, technology, and energy have been the two strongest sectors on average, the first 12 months after the first hike. Why is that? Because the Federal Reserve usually raises rates when the economy, demand, and inflation is strong enough to tolerate tighter policies.

Starting point is 00:02:02 Higher rates lower the value of future cash flows, but strong earnings and productivity can offset that valuation pressure. This is the same higher interest rate paradox we've discussed in the past. Interest rates matter, but the reason interest rates are rising matter more. So the first point is simply a rate hike is a yellow flag, not automatically a red light. And if you're approaching retirement, understanding those yellow lights matter because your portfolio may soon be funding your paycheck. Subscribe to the channel and ring that notification bell for more discussions about how markets, income, and taxes fit into your retirement plan.

Starting point is 00:02:37 So okay, on to point number two. Earnings are still the bull markets' best defense. Now we get to what I think matters most. Earnings. Factsets early October numbers show analysts actually raised third quarter S&P 500 earnings estimates, during the quarter. That's very unusual. Third quarter estimate rose about 1.4% from the end of the second quarter through September, while estimates normally fall by 2 to 3% during a quarter. The current estimate is about 29.5% year-over-year earnings growth for the third quarter. That holds

Starting point is 00:03:12 it would be the third straight quarter with earnings growth above 25% in the eighth straight quarter of double-digit earnings growth. Work from Citadel Securities and FACSET, Tell a similar story. Corporate profits rose 22.8% year-over-year in the second quarter to a record $4.83 trillion. Third quarter earnings estimates have continued moving higher and companies have been clearing a rising earnings bar. And valuations have already adjusted. The SP 500 is around 19 times forward earnings close to its 10-year average. Semiconductors have seen a much larger valuation reset. In other words, higher bond yields have already taken some air of the P.E. multiple. That doesn't make stocks cheap, but it means the market is no longer relying on only multiple expansion. Earnings now have to do more of the work, and so far they are. This is the

Starting point is 00:04:04 key test for the next few weeks. If earnings estimates keep rising while rates rise, the bull market can survive. If earnings estimates roll over, while real yields stay high, the math gets much more difficult. Okay, point three, the midterm election cycle is starting to flip positive. The third piece is the calendar. The election cycle chart shows why the next several months are interesting. Year two, the midterm year, has historically been the difficult part of a four-year presidential cycle, but the weakness has often been front-end loaded. As the year moves forward to the fourth quarter, the historical pattern usually improves. The data going back to 1930 shows the S&P 500 has gained an average 5.6% in the fourth quarter, the midterm years, and almost twice the 2.9%

Starting point is 00:04:51 and average for all other years. October and November have historically been the strongest months of the midterm calendar. But here's the catch, and it matters for anyone watching the market day-to-day. The fourth quarter low occurred in October in 14 of 24 midterm years or 58% of the sample. From that fourth quarter low, the median rally into year end was about 10%. And investors remember Donald Trump's last midterm election was when? It was the fourth quarter, And back then, the S&P 500 dropped almost minus 19.9% into Christmas Eve, as the Fed and Jerome Powell said, they weren't yet tight enough. So a positive seasonal setup isn't a guarantee and doesn't mean a straight line higher. It can mean weakness at first, then strength.

Starting point is 00:05:41 That fits the rate height history as well. Volatility often rises before the market finds its footing. For retirees, that distinction matters. normal correction inside a continuing earnings cycle is very different from a fundamental breakdown in earnings credit for the economy. So our fourth and final point, the April 2025 V-bottom is now 18 months old. That's the part that keeps me from getting too comfortable. The V-bottom from April 4th, say April 8th, 2025 tariff shock is now about 18 months old. The market has had a powerful recovery, and recoveries eventually have to prove that they can,

Starting point is 00:06:19 can survive without the easy rebound math. The warning signs are not hard to find. Many strategists are noting weak breadth and the S&P 500 is near its all-time highs, but only about 25% of its members were above their 50-day moving average at the end of the quarter. In third quarter, the S&P 500 gained about 2%

Starting point is 00:06:39 while the equal weight fell minus 2%. And the Russell 2000 fell minus 7%. Semiconductors, they were down almost 11,000. percent in the quarter. However, investors, the magnificent seven just gained 11 percent. Even more striking, Microsoft, Nvidia, Apple, and meta contributed roughly 300 S&P 500 points during the third quarter. That was more than 200 percent of the index's entire gain, while the rest of the index collectively detracted 150 points. That's not automatically bearish. A cap-weighted index can keep rising with narrow leadership. But it does make the market more

Starting point is 00:07:19 more fragile if those leaders start to stumble. And remember the volatility chart. And every first hike cycle shown since 1994, both the S&P 500 and the NASDAQ, experienced a meaningful three-month drawdown after the first Fed hike. The average experience is not Fed hikes, stocks go straight up. The experience is Fed hikes, volatility rises,

Starting point is 00:07:42 then earnings decide what happens next. That is why I would call the current setup constructive, but less forgiving than it was April of 2025 during the tariff lows. So our call put all four pieces together. First, rate increases alone have rarely been enough to kill a bull market. Second, earnings growth is still unusually strong and estimates are rising. Third, the midterm calendar is shifting from a seasonal headwind toward a historical tail win. Those are the three real positives, but the fourth point is the one I would keep on the dashboard. Rebound is no longer young. Market breadth is weaker,

Starting point is 00:08:19 ownership is concentrated, Treasury yields are higher. And history says volatility around a new interest rate hiking cycle is normal, not unusual. So my answer is not, rates don't matter. They absolutely matter. Higher rates, lower PE ratios, and raise the return investors can earn in bonds and in cash. But a low market usually ends from the rate pressure damages earnings, liquidity, credit, or economic growth, not simply because the Fed raises rates once. For retirees and near retirees. I would watch three things more closely than the daily Fed headlines, earnings revisions, market breadth, and credit conditions. If earnings keep rising and breadth begins to improve, higher rates may remain a headwin instead of a roadblock. If earnings weaken and credit spreads

Starting point is 00:09:05 widen while rates stay high, that call changes quickly. That is the market's version of you make the call. The evidence is still constructive, but at 18 months off a V-bottom, the burden of proof is getting higher. But your retirement shouldn't depend on getting the next market call right. The more personal question is, rates stay higher, earnings weekend, or stocks pull back, how could that affect the income you're counting on? That's where these market discussions connect to your retirement plan, your withdrawals, investment mix, taxes, and ability to handle losses. If you'd like some help evaluating how these pieces work together, call O'Carvis Financial Group at the number in the description to schedule a review of your retirement plan.

Starting point is 00:09:46 plan. We can discuss your goals, examine the tradeoffs, and identify areas that may need attention, so you better understand your plan and the risk it needs to account for. All content contained with an Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change. without notice. Strategies and ideas discussed may not be right for you, and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation

Starting point is 00:10:29 to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment, and your investment results may differ when compared to an index. Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss, and past performance is not indicative of future results.

Stock Talk - Will Higher Interest Rates Stop the Bull Market?

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.