The Federal Reserve Just Warned More Rate Hikes Are Likely Coming. History Has Good and Bad News for Investors

The S&P 500 has roared higher over more than three years, extending a bull market, with investors piling into artificial intelligence (AI) stocks and other growth players. The famous benchmark is heading for an increase of about 100% since the start of 2023. Investors have been eager to get in on the next big thing in technology, and in recent years, the generally positive economic backdrop has buoyed demand for growth-oriented stocks.

But in more recent times, one stubborn problem has knocked on the door: rising inflation. Turmoil in Iran has led to surging energy prices, and that's weighed on households and the corporate world. The Federal Reserve stepped in last month, doing something for the first time in three years. Policymakers lifted the benchmark interest rate, the federal funds rate, by a quarter point to the range of 3.75% to 4%.

And the Fed just warned that more rate hikes are likely coming. Against this backdrop, history has good and bad news for investors.

Image source: Getty Images.

The recent stock market situation

First, though, let's start with a summary of the market situation over the past few years. As mentioned, the S&P 500 has climbed amid excitement over AI and demand for growth stocks in general. The economic environment in the early days of this movement was supportive, but progressively, inflationary pressures emerged and worsened amid soaring oil prices this year.

Even with this headwind present, the S&P 500 has advanced, reaching multiple record highs. AI stocks have faced more difficult trading days than they did in the past, but they still have climbed, many in the double and triple digits.

The Fed, in a move to tame inflation, last month lifted rates and, in the Federal Open Market Committee meeting minutes, warned that more rate hikes are likely coming.

"With regard to the outlook for monetary policy beyond the current meeting, most participants assessed that another increase in the target range for the federal funds rate would likely be appropriate by year end," the policymakers wrote. The Fed also emphasized its commitment to pursuing its dual mandate of maximum employment and price stability.

Meanwhile, the probability of a rate hike during the Fed's December meeting has reached more than 88%, according to CME Group's FedWatch tool.

Though expectations are for no change at the policymakers' next meeting at the end of this month, all of the above support the idea of another rate increase just beyond that point.

The bad news and the good news

Now let's consider the bad and good news for investors. The bad news is that higher interest rate levels generally aren't positive for the stock market. For a couple of reasons. First, higher rates may be a drag on corporate earnings, as they represent greater borrowing costs for companies and pressure on revenue for companies heavily depending on consumer spending. During times of higher rates, consumers' wallets feel the pressure as they face higher rates on credit cards and student loans, for example. And they generally favor spending on essentials over discretionary purchases. This may equal lower revenue for certain companies. Also, during periods of higher interest rates, some investors prefer bonds, as they offer higher yields and are seen as less risky than stocks.

And all of this may translate into weaker performance for the stock market. Anticipating this, certain investors may hesitate to buy stocks, compounding the problem.

Now, here's the good news. History shows us that, though the S&P 500 may fall in anticipation of and during times of higher rates, these tough times aren't long-lasting.

^SPX data by YCharts

As the chart above shows, the index has always recovered and gone on to gain significantly in the years to follow.

So what does this mean for you as an investor? Periods of higher interest rates are buying opportunities. At these moments, you may find many quality stocks trading at very reasonable valuations, so it is the moment to pick them up at a bargain and hold on. History has demonstrated over and over that this move may offer you spectacular results over the long run.

Adria Cimino has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.