The Rate Hike Rorschach Test: Bulls and Bears Square Off Over Year-End Rally Odds

The Federal Reserve’s decision to raise interest rates this week has reignited the debate over whether the impending rate hike will spell doom for stocks or merely be a speed bump on the way to a strong finish. Some experts warn that higher borrowing costs will squeeze corporate margins and consumer spending, while others point to historical precedent as evidence that this year’s rate hike will be just another blip on the radar.

The so-called September Effect – which has stocks performing poorly in the month due to factors such as tax-loss selling and back-to-school expenses – is once again a concern. This year’s confluence of war-driven oil price increases, economic uncertainty, and higher interest rates has led some analysts to declare that market psychology is working against investors. However, others are more optimistic about the prospects for a positive October surprise.

The divergent views on rate hikes are nothing new. In fact, they’re a hallmark of this perpetual Rorschach test that investors face every time the Fed raises rates. Goldman Sachs CEO David Solomon’s recent comments about his bank’s fixed-income trading business being “a little bit softer” this quarter have already sent his company’s shares tumbling 4%.

Macro Risk Advisors CEO Dean Curnutt is one expert who thinks that higher interest rates will be particularly problematic, citing the risk posed to corporate margins by increased borrowing costs. He notes that 2018’s lackluster performance – characterized by a September rate hike, surging bond yields, protectionist trade policies, and a rotation out of Big Tech stocks – is a warning sign for this year’s economic backdrop.

Not all experts share Curnutt’s pessimism, however. Citadel Securities has become increasingly constructive about the market’s end-of-year prospects, pointing to historical data that suggests the S&P 500 tends to bounce back in October after a September decline. Since 1930, the index has fallen an average of only 1.1% in the last two weeks of September before rebounding in October. In midterm election years – and this is one – the index has gained a respectable 5.6% from the end of September through New Year’s Eve.

Goldman Sachs also sees reasons for optimism, noting that while the S&P 500 has declined an average of 2% in the first three months of seven rate-hiking cycles, it ultimately posted an average 12-month gain of 9%. This raises a question: what’s behind this seemingly contradictory evidence? Is the market simply trying to tell us something about its own inherent resilience, or are we seeing a classic case of investors being fooled by historical trends?

Ultimately, the outcome will depend on the interplay between various factors at play. Will higher interest rates slow corporate borrowing and consumer spending enough to cause a significant pullback in stocks? Or will investors continue to bet on the “Santa Claus rally” – that phenomenon where the S&P 500 tends to rise from late November through January? Only time will tell, but one thing is certain: this year’s rate hike has set off a game of Rorschach test chicken among bulls and bears.