In a widely expected move on Wednesday, the Federal Reserve wrapped up its two-day policy meeting by announcing a third consecutive 75-basis-point interest rate hike, raising borrowing costs to their highest level since the Great Recession.
Stocks immediately tanked in volatile trading after the news, and bond yields have continued to surge higher in anticipation of more rate hikes. The yield on the 2-year Treasury note surpassed 4% on Wednesday for the first time since 2007, while the 10-year Treasury topped 3.6% earlier this week—its highest level since 2011.
What does it all mean for investors? In short, not much if they’re thinking about a long term outlook. “While the long term odds are becoming more favorable in terms of stocks coming down to better valuations, the near-term odds favor high-risk” as the Fed keeps raising rates, with “stormy seas” still ahead, says James Stack, president of InvesTech Research and Stack Financial Management.
With investors trying to figure out how high the central bank will raise rates and how that could affect the economy, many eyes are on the “terminal rate,” or the point at which central bank officials think they can stop hiking interest rates. The central bank now predicts the federal funds rate will reach 4.4% by the end of this year and 4.6% by the end of 2023. That’s up from its previous forecast of 3.4% and 3.8%, respectively.
“At this point in the tightening process, we think the ceiling is much more important than the pace – the market wants to know where the Fed is going, not how fast it plans to get there,” says Adam Crisafulli, founder of Vital Knowledge.
There’s good news for investors who can weather the short-term volatility and stay focused on long-term opportunities, experts say. What’s more, the year after a midterm election is historically the best for markets, with the S&P 500 rising an average of 16%, per CFRA data.
While markets may continue to struggle through the end of the year, “history shows improved market performance following midterm elections, so we encourage investors to maintain targeted allocations,” says John Lynch, chief investment officer for Comerica Wealth Management.
Though he predicts stocks are likely to retest their June low point—especially when also considering the alarming headlines around the election and the War in Ukraine, investors should still recognize the importance of adhering to long-term targeted allocations, Lynch argues. “Markets may be volatile, but they often prove resilient for patient investors,” he adds.
In the near term though, investors can expect what is historically a volatile period for markets as midterm elections loom in November. The second year of a presidential cycle produces the lowest average S&P 500 return of just 4.9%, with an average decline of 1.8% and 0.5% in the second and third quarter, respectively, according to CFRA Research. Market volatility is typically 70% higher than the average for all other quarters in the four-year presidential cycle.
Stack’s advice for investors: Be patient, hold positions and focus on defensive sectors like utilities, which have less downside risk in a downturn. “It’s important to stay focused on the long term and remain optimistic—there will be another side to this valley, but it would also be dangerous to ignore the near-term risk of tighter Fed policy on both the economy and the overinflated housing market,” Stack says. In the meantime, investors should “maintain defenses and keep powder dry” for future opportunities.