With Nov. 8 behind us, equity investors now await the next big date on the calendar: the Dec. 15-16 Federal Open Market Committee meeting.
After initially falling on news of Donald J. Trump's victory in the presidential election, within hours the futures market was back to pricing in an 84% chance that the U.S. Federal Reserve would raise its benchmark interest rate in December. It's a natural response to a possible impact of the election: The president-elect's expected push for tax cuts and infrastructure spending could play into Fed Chairwoman Janet Yellen's recent calls for more fiscal stimulus that would allow the Fed to take its foot off the monetary accelerator.
Still, given the questions surrounding a Trump presidency, some investors worry that a December rate hike could be one bout of uncertainty too many. This concern stems in large part from established theories that interest rates and stock prices, specifically price-earnings ratios, are negatively correlated — with low interest rates historically accompanied by high P/Es, and vice versa. However, we have long suspected the relationship was more complicated than that. Before the election, we conducted a study examining 150 years of data on P/Es and rates. Our findings suggest investors have less reason to worry about the impact of a December rate hike than they might think. In fact, we argue investors should be more worried if the Fed finds itself unable to raise rates.