Stocks could have a tough road ahead if the Fed hikes rates: Chart of the Day

As oil prices surge past $100 per barrel and the US economy added more jobs than anticipated in August, the Federal Reserve faces increasing pressure to raise interest rates, potentially marking a tough period for stocks. Goldman Sachs analysts predict that the benchmark S&P 500 index typically experiences a negative 2% return at the start of a Fed hiking cycle.

This is due to economic growth often taking precedence over rate levels, and past high-valuation bull markets historically peaking at the start of tightening cycles. Additionally, the AI boom has made the current growth cycle particularly capital intensive, increasing sensitivity to changes in the cost of capital. Goldman Sachs notes that even a modest hiking cycle could weigh on stocks due to the difficulty in predicting the duration and magnitude of tightening.

However, they also emphasize that the long-term picture remains secure, with the S&P 500 averaging a 12-month return of 9% despite negative returns in the first three months of tightening cycles. To offset the impact of a one percentage-point increase in the cost of capital, companies would require a 2% increase in expected long-term growth.

The analysts believe that investors may have already accounted for rising rates, as the market has priced in three hikes within the next year. Nonetheless, they expect the bull market to continue, driven primarily by strong earnings growth.