Rising Rates Not a Dealbreaker for Stocks

• Historical data shows stocks can perform well during 'slow' rate hike cycles, gaining an average of 10.5% in the first year when the Fed waits between moves, versus losing 3.6% during 'fast' cycles with consecutive hikes.
• High and stable interest rates have historically been the best environment for stocks, producing 5.4% quarterly returns with 90% positive outcomes since 1999, while falling-rate regimes were the worst performers.
• The S&P 500's forward P/E ratio of 19x is below its five-year average of 19.8x, yet stocks are up 12% year-to-date due to strong earnings growth compensating for valuation compression from higher rates.

Summary

Key Thesis: Rising interest rates to 5% do not necessarily signal the end of the equity bull market, as strong earnings growth can offset valuation pressure.

Main Data Points:

• 10-year Treasury yield crossed 5% for the first time since July 2007
• Federal Reserve hiked rates by 25 basis points
• S&P 500 forward P/E ratio at 19x, below five-year average of 19.8x
• Stocks up ~12% year-to-date despite rate increases
• Consensus estimates show 33%+ earnings growth for 2026, 17% for 2027
• Atlanta Fed GDPNow tracking Q3 growth at 5.1%
• August unemployment steady at 4.1% with 162,000 jobs added

Market Implications:

The analysis distinguishes between two rate-hiking scenarios: dangerous inflation-driven tightening (1973, 1981, 2022) versus benign "reflation" cycles (1957, 1994, 2004, 2015). Current conditions resemble the latter, with robust economic data supporting continued earnings growth.

Historical analysis from Ned Davis Research shows "slow" hiking cycles (spacing between rate increases) produced +10.5% average first-year stock gains, while "fast" cycles resulted in -3.6% losses. Counterintuitively, high-and-stable rate environments generated the best quarterly returns (+5.4%) since 1999.

Outlook:

RiverFront expects approximately two more rate hikes before the cycle peaks, with mid-to-long term rates nearing their top. The firm remains overweight equities in balanced portfolios, prioritizing earnings trends over absolute yield levels. Key risk: a fast-hiking cycle concurrent with earnings deterioration—not the current expectation.

Bottom Line: Elevated rates alone are not equity bearish; deteriorating fundamentals combined with aggressive Fed tightening pose the real threat.