Why Stocks Could Defy Fed Rate Hikes: ETFs to Watch

The stock market has enjoyed a strong run this year, and investors are wondering whether the rally can continue even as bond yields climb and the Federal Reserve looks likely to enact a rate hike this month.

Markets priced in a 25-basis-point rate hike on Wednesday, with the probability of a hike estimated at roughly 90%, following a stronger-than-expected core inflation reading.

However, note that the S&P 500 is still within about 2% of its record closing high. This resilience is notable because higher bond yields typically make stocks less attractive by increasing borrowing costs and reducing the present value of future earnings.

But this time, the story may be a little different. Strong corporate profits, a resilient economy and a shift toward more normal interest rates could help keep stocks on an upward path (read: Guide to S&P 500 ETF Investing).

Here are some reasons the rally may have further room to run.

1. Strong Earnings Are Keeping Investors Bullish

Corporate earnings remain one of the biggest reasons stocks have held up so well. S&P 500 earnings jumped 52% year over year in the second quarter, giving investors a solid reason to remain optimistic despite higher interest rates.

Jeff Schulze, head of economic and market strategy at ClearBridge Investments, told Yahoo Finance that markets have been taking their cues from the strong earnings environment.

Investors should note that S&P 500 earnings growth has been strong over the past two years, but the current momentum stands out. Growth is accelerating and becoming increasingly broad-based across sectors, creating a supportive backdrop for stocks.

For Q3 2026, S&P 500 earnings are expected to rise 23.0% year over year, while revenues are projected to grow 11.1%. Earnings are expected to increase in 14 of 16 sectors, with six delivering double-digit growth, per the Earnings Trends issued on Sept. 2, 2026.

For full-year 2026, S&P 500 earnings are projected to climb 27.6%, though growth would moderate to 14.8%, excluding Tech. Earnings are expected to rise in 15 of 16 sectors, with nine posting double-digit growth.

2. History Favors a Strong Finish

The market’s performance through August also offers a reason for optimism.

According to Schulze and his team, the S&P 500 has gained more than 10% through August on 28 occasions. In 25 of those years, the index advanced between September and December. That’s an 89% success rate, as quoted in the same Yahoo Finance article.

Yes, the index has pulled back from its mid-August peak, but remains close to its record high. This suggests that investors have not abandoned stocks, even as the 10-year Treasury yield climbed to its highest level since 2023.

3. Rising Yields May Signal a Stronger Economy

Higher bond yields are not always bad news for stocks. What matters is why yields are rising.

Schulze pointed out that much of the recent increase in the 10-year Treasury yield has come from higher real rates, or inflation-adjusted interest rates. Since late February, real rates have risen by 50 basis points compared with a 15-basis-point increase in inflation expectations and a 17-basis-point rise in the term premium.

This suggests that investors are responding more to stronger economic growth, increased AI infrastructure spending and changing expectations for Fed policy than to fears of a major inflation or fiscal crisis.

4. Stock Rally Depends on Long-Term Rates More

Long-term Treasury yields, especially the 10-year yield, are important for stock valuation because they influence the discount rate that investors use to value future corporate earnings.

On the other hand, the Fed controls the federal funds rate, which influences short-term Treasury yields. A Fed rate hike could put some pressure on stocks, but it may not necessarily derail the rally. Hence, while many fear a crash in growth ETFs like Invesco QQQ ETF QQQ, reality may not be that harsh.

5. Relief Rally Expected Post Midterm Election?

Since 1974, the S&P 500 has delivered an average return of just 1.7% from Aug. 1 through Election Day, per Charles Schwab. But markets normally see a “relief rally” in the months after an election. Since 1974, the S&P 500 has averaged a 5.7% return in the three months immediately following a midterm election, with 11 of the 13 years producing a positive return. 

And in the six months following a midterm election, the S&P 500 has averaged a 12.4% return across the same years, with all 13 years showing positive returns, per Charles Schwab. All these historical data points indicate a potential rally in ETFs like Vanguard 500 Index Fund ETF Shares VOO and Invesco S&P 500 Equal Weight ETF RSP (read: Midterm Takes Center Stage: What Does It Mean for Markets & ETFs?).

6. AI-Driven Activities to Rule Ahead

Global data center capital expenditure is projected to top $3 trillion by 2030, due to investments in artificial intelligence infrastructure, according to a Dell’Oro Group report, as mentioned in an Economic Times report. This surge is expected to pull off the broader stock market and ETFs in the coming days.

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This article originally published on Zacks Investment Research (zacks.com).

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