S&P 500 Record High Despite Rising Rates: Why

This article explains why the S&P 500 can hit record highs even as interest rates rise, and what it means for investors. The short answer: stocks are pricing in stronger future corporate earnings, not today’s borrowing costs, and rate hikes often reflect a healthy economy that supports profits. Below, we break down the mechanics, historical context, and what to watch.

Formula

The simplified fair P/E ratio is calculated as:

Fair P/E = Current P/E × (1 + Expected EPS Growth) / (1 + 10-Year Treasury Yield)

Where:

• Current P/E: the price-to-earnings ratio of the S&P 500 (unitless).
• Expected EPS Growth: the percentage increase in earnings per share expected over the next year (as a decimal in the formula).
• 10-Year Treasury Yield: the yield on the 10-year U.S. Treasury note (as a decimal in the formula).

This is a simplified version of the Fed Model, which compares stock earnings yields (E/P) to bond yields.

Worked Example

Using the default values from the calculator:

• Current P/E = 20
• Expected EPS growth = 10% (0.10)
• 10-Year Treasury yield = 4.5% (0.045)

First, compute the growth factor: 1 + 0.10 = 1.10

Next, compute the discount factor: 1 + 0.045 = 1.045

Then, the fair P/E = 20 × 1.10 / 1.045 = 22 / 1.045 ≈ 21.05

The implied S&P 500 level is 100 × 21.05 = 2105 (this is just a scaled index value for illustration).

So, with higher expected earnings growth, the P/E can stay elevated even when rates rise.

Why Rates and Stocks Often Move Together

Conventional wisdom says rising interest rates are bad for stocks because they increase borrowing costs and make bonds more attractive. However, the S&P 500 has repeatedly hit record highs during rate-hiking cycles. The key reason: the Federal Reserve typically raises rates when the economy is strong, unemployment is low, and consumer spending is robust. Strong economic growth directly boosts corporate profits, and investors look ahead to those profits when setting stock prices.

For example, from 2015 to 2018, the Fed raised rates nine times, yet the S&P 500 gained about 20% over that period. Similarly, in 2023, the Fed hiked rates to a 22-year high, but the index still rose over 20% due to resilient earnings, especially in technology and consumer sectors.

How Higher Rates Actually Affect Stocks

Higher interest rates affect different sectors differently. Here’s what happens:

• Growth stocks (tech, biotech) are more sensitive because their value depends on future earnings, which are discounted at higher rates. But if those future earnings grow fast enough, the stock price can still rise.
• Value stocks (financials, energy) often benefit from higher rates because banks earn more on loans and energy prices tend to rise with inflation.
• Dividend stocks (utilities, real estate) become less attractive because bonds offer similar income with lower risk.

The net effect on the S&P 500 depends on the mix. When earnings growth is broad-based, the index can shrug off rate hikes.

Earnings: The Real Driver

Stock prices ultimately follow earnings. In 2023 and 2024, S&P 500 companies posted record profit margins, driven by cost-cutting, productivity gains from AI, and pricing power. Even with higher borrowing costs, companies generated enough cash to buy back shares and pay dividends, supporting stock prices.

For instance, in the first quarter of 2024, S&P 500 earnings grew about 5% year-over-year, beating expectations. When earnings exceed forecasts, investors raise their price targets, pushing the index to new highs.

Historical Patterns and Exceptions

Historically, the S&P 500 has risen during most rate-hiking cycles since World War II. The exceptions are when the Fed hikes too aggressively, causing a recession. For example, in 1981, the Fed’s high rates crushed stocks because inflation was out of control. In 2000, rate hikes popped the tech bubble. But in most cycles, the economy absorbed higher rates without a recession, and stocks continued upward.

Today, the current cycle is unusual because rates rose from near zero to over 5% in just two years—the fastest in decades. Yet the economy has remained resilient, thanks to strong consumer balance sheets and government spending. This has allowed earnings to keep pace.

Common Mistakes and Misconceptions

A common mistake is assuming that a rate hike automatically triggers a stock market drop. In reality, markets often rally after hikes because they signal confidence in the economy. Another misconception is that “rising rates” means all rates—but the Fed controls short-term rates, while long-term rates (like the 10-year Treasury) are driven by inflation expectations and growth. Sometimes short-term rates rise while long-term rates fall, which is actually bullish for stocks.

Another error is ignoring the pace of change. A gradual rate increase gives businesses time to adjust, while a sudden spike can cause panic. The current cycle has been rapid, but investors have focused on the “higher for longer” narrative, which has not yet broken earnings momentum.

Limits of the Simple Model

The formula above is a simplification. Real stock valuation uses many factors: risk premium, global growth, currency moves, and geopolitical events. The Fed Model has been criticized because it ignores the equity risk premium—the extra return investors demand for holding stocks over bonds. When that premium shrinks, stocks can be overvalued. Also, the model assumes earnings growth is constant, which is rarely true.

Nevertheless, the core insight holds: if earnings grow faster than the discount rate, stock prices can rise. That’s why the S&P 500 can hit records even with rising rates.

Frequently Asked Questions

Why did the S&P 500 hit a record high when the Fed raised rates?

Because corporate earnings grew strongly, and investors expected that growth to continue. Higher rates reflect a strong economy, which boosts profits. As long as earnings growth outpaces the discounting effect of higher rates, stock prices can rise.

Does rising interest rates always hurt stocks?

No. It depends on why rates are rising. If rates rise due to strong demand and inflation, stocks can do well. If rates rise because the Fed is trying to cool an overheated economy, stocks may struggle. The key is the balance between growth and rates.

What is the relationship between the 10-year Treasury yield and the S&P 500?

The 10-year yield is a benchmark for discounting future cash flows. When it rises, future earnings are worth less today, which can lower stock prices. However, if earnings expectations rise faster, the net effect can be positive. The relationship is not fixed.

Are we in a stock market bubble?

Some metrics like the Shiller P/E ratio are above historical averages, suggesting overvaluation. However, low unemployment, strong earnings, and technological innovation support higher valuations. Bubbles are only clear in hindsight. It’s wise to diversify and focus on long-term goals.

What should an investor do when rates are rising?

Focus on companies with strong cash flows, pricing power, and low debt. Sectors like financials, energy, and healthcare tend to perform well. Avoid overvalued growth stocks with no earnings. Maintain a diversified portfolio and consider bonds with shorter durations to reduce interest rate risk.

How does the S&P 500 compare to bonds during rate hikes?

Historically, stocks have outperformed bonds over the long term, even during rate hikes, because earnings growth compounds. However, bonds provide stability and income. A balanced portfolio of both is often recommended, with the stock-bond mix based on your risk tolerance and time horizon.

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in p | Current P/E | - | 20 | 0
in e | Expected EPS growth % | % | 10 | 0
in r | 10-year Treasury yield % | % | 4.5 | 0
out f | Fair P/E (simplified) | - | p * (1 + e/100) / (1 + r/100) | 1
out s | Implied S&P 500 level | - | 100 * f | 0