Markets Are Pricing in a Fed Rate Hike in December. Here's What Investors Should Do, According to History.

The Federal Reserve is contemplating a rate hike in December, as indicated by the CME Group's FedWatch projecting an 81.2% probability. This raises questions for investors about their actions. However, history offers some guidance on this matter.

Investors might be inclined to sell off their stocks, but this is not advisable. After a new rate hike cycle, the S&P 500 has typically risen by around 9% over the subsequent 12 months, according to Goldman Sachs research. Although the index usually declines by about 2% in the initial three months following the first hike, selling stocks early would have likely resulted in losses for investors in the past.

Certain sectors have outperformed others during periods of rising interest rates. Energy stocks, for instance, were the top performers during the Fed's last significant series of rate hikes from March 2022 to July 2023. The State Street Energy Select SPDR ETF, which includes 21 leaders in the energy sector, surged by approximately 18% during this period. Notably, ExxonMobil and Energy Transfer LP experienced even higher returns.

For investors with bond holdings, it is advisable to shift from long-duration to short-duration bonds. When interest rates rise, bond prices typically fall, with longer-duration bonds being hit the hardest. Currently, investors can purchase short-term U.S. Treasury bonds, which are essentially risk-free, and earn yields above 4%.

Moreover, the Federal Reserve's actions warrant careful analysis beyond the December vote. Investors should closely examine the updated dot-plot projection, which illustrates the expectations of individual FOMC participants regarding short-term interest rate movements. Pay particular attention to the speed at which policymakers anticipate rate increases. Goldman Sachs research indicates that particularly aggressive rate hikes have led to worse stock market performance in the past.