The Fed raised interest rates 0.25%, the first interest rate increase since 2006. The rate increase was widely expected, but equities rallied strongly shortly after the news, with the S&P 500 rising 29 points, or 1.43%, to 2073. This marks a sea change in the stock market since last Friday, when the S&P 500 closed at 2012, down 4% on the week.
Despite significant volatility in recent weeks, the S&P’s close 12/16/15 puts it up 0.73% on a price change basis for the year: much ground has been traversed, with little net gain to show for all of the movement and volatility.
The key for investors now will be to gauge the capital markets’ reaction to the Fed’s move. We believe it is a shot across the bow for bond investors: yields are likely to move higher, and that negatively impacts bond prices.
Equity investors will be focused not only on the impact of higher interest rates on stock valuations going forward (we believe that equity valuations have plenty of slack at present to absorb higher interest rates, because current interest rates remain far below historic levels), but will also be looking to the next quarterly earnings reporting period, which will get underway in earnest on January 11.
The Fed signaled that further increases in interest rates are likely in 2016, based on the Fed’s assessment of economic data as it unfolds.
We continue to believe that stocks are generally trading close to our estimate of fair value for 2015, and about 8-10% below our estimate of fair value for year-end 2016 (which implies mid-to-high single digit returns for stocks in the aggregate in 2016 from current levels). Stocks continue to be more attractive than bonds, which will need to reach higher interest levels before they become attractive.