If an interest rate hike cycle begins, which stocks will be most resilient? Barclays: Historically, only energy stocks have bucked the trend and closed higher.

Market expectations are rising for a Federal Reserve rate hike in early 2027. Barclays research indicates that the S&P 500 median will fall 3.9% after the rate hike begins, with small-cap and financial stocks leading the decline, reflecting a shift in market style towards large-cap and value stocks. Energy stocks, supported by commodities and real demand, have become the only sector in history to record positive returns in the quarter following the first rate hike.

Market expectations for a Federal Reserve rate hike in early 2027 continue to rise. A recent Barclays study shows that once the rate hike cycle begins, the stock market as a whole will be under pressure, but energy stocks are the only sector in history that has been able to record positive returns within a quarter following the first rate hike.

According to a report released on August 24 by Barclays strategists Venu Krishna, Riddhiman Dass, and others, data from the past five interest rate hike cycles shows that in the quarter following the first rate hike, the S&P 500 index fell by a median of 3.9%, small-cap stocks fell even more sharply by 7.2%, and financial stocks performed the worst, with a median decline of 8.4%. Meanwhile, in terms of style factors, value stocks outperformed growth stocks, and large-cap stocks significantly outperformed small-cap stocks.

Recent increases in long-term U.S. interest rates, with the yield on 30-year Treasury bonds reaching its highest level since 2001, have led the market to price in a possibility of a rate hike at the Federal Reserve's January 2027 meeting. While Barclays economists predict no rate hikes by the Fed in the first half of 2027, this structural shift in market expectations has prompted the strategy team to re-examine historical patterns in stock market performance during the initial stages of rate hikes for investor reference.

Long-term rates are under pressure, and interest rate hike expectations are coming forward.

The US interest rate market has recently seen significant fluctuations. Despite persistently weaker-than-expected economic data, including non-farm payrolls, inflation, and retail sales, long-term interest rates have risen rapidly, with the yield on 30-year Treasury bonds reaching its highest level since 2001. The US Treasury has begun intervening in the bond market to manage rising interest rates, but this move has also raised concerns about potential side effects.

According to Barclays interest rate strategists, the main drivers of this round of long-term interest rate increases are the large-scale issuance of long-term bonds by artificial intelligence-related companies and the increasing price sensitivity of investors. Meanwhile, short-term interest rates are also showing signs of pressure.

At the market pricing level, the implied policy rate path has clearly shifted towards a hawkish direction, with the market gradually incorporating a rate hike at the first FOMC meeting in January 2027 into its expectations, even though overall inflation expectations have recently declined. Barclays economists maintain their baseline assessment that the transmission path from CPI, PPI, and import price data to core PCE is sufficiently moderate, and the Fed will remain on hold in the first half of 2027, but acknowledges that the shift in market expectations warrants close monitoring.

Historical pattern: A clear turning point in sector performance occurs before and after interest rate hikes.

This Barclays study covers five interest rate hike cycles: February 1994 to February 1995, June 1999 to May 2000, June 2004 to June 2006, December 2015 to December 2018, and March 2022 to July 2023. These five cycles were characterized by diverse macroeconomic backdrops, ranging from tightening driven by strong real economic growth to interest rate hikes primarily aimed at suppressing inflation.

Research has found that the start of an interest rate hike cycle marks a clear turning point in the stock market's leading sectors. In the quarter preceding the first rate hike, the market as a whole remained in an upward trend, with the S&P 500 showing a median gain of 2.2%. The energy and industrial sectors led the gains, both with median gains exceeding 7.5%, while the communication services sector declined by approximately 2%.

However, once the interest rate hike was implemented, the stock market sentiment quickly reversed. In the quarter following the first rate hike, the S&P 500 median fell 3.9%, and the Russell 2000 small-cap index median fell by 7.2%. At the sector level, financial stocks saw the steepest median decline, reaching 8.4%; traditionally defensive sectors such as healthcare, utilities, and consumer staples also experienced significant drops. While industrials, materials, and consumer discretionary sectors also saw substantial corrections, their declines were less severe than those of the defensive sectors; technology and communication services saw relatively moderate declines, outperforming the broader market.

Energy stocks: the only sector to buck the trend and close positive.

Among all sectors, energy stocks were the only sector to achieve positive returns in the quarter following the first rate hike, with a median increase of 0.3%, and consistently outperformed the S&P 500 in all five cycles. This performance is highly consistent with the pattern of the entire rate hike cycle—in the five complete rate hike cycles in history, energy stocks have also ranked among the top sectors in terms of median annualized performance.

Barclays strategists point out that the start of an interest rate hike cycle typically occurs late in an economic expansion, when economic growth remains resilient. Against this backdrop, the energy sector benefits from supportive commodity prices and pricing in strong demand from the real economy.

In contrast, the negative reaction of financial stocks to the start of interest rate hikes has its own inherent logic: the banking sector relies on healthy credit demand, low financing costs, and manageable credit risk, while the tightening of financial conditions and the flattening of the yield curve brought about by interest rate hikes both put pressure on banks' net interest margins. The predicament of defensive sectors is also understandable—in the late stages of a still robust economic expansion, the Fed's tightening signals mean that the market's valuation premium for stable cash flow and solid earnings will be compressed.

Style Factors: Value outperforms growth, large-cap stocks outperform small-cap stocks

At the style factor level, the start of the interest rate hike cycle also brings about a significant rotation effect. The Fama-French small-cap relative to large-cap factor weakened continuously for the first two months after the first rate hike, followed by a relatively long period of recovery. The momentum factor performed strongly in the weeks leading up to the rate hike, but its trend tended to be volatile after the rate hike was implemented.

The shift in value relative to growth was evident in both quarters following the first interest rate hike. In large-cap stocks, this manifested as a gradual trend of growth underperforming value; while in small-cap stocks, the disadvantage of growth relative to value became apparent rapidly within two months of the rate hike, with a more dramatic reversal.

Barclays strategists caution that all the above conclusions are based on a historical sample of five interest rate hike cycles, which has a relatively limited sample size, and past performance does not guarantee future returns. However, in terms of consistency, the pattern of energy stocks consistently outperforming, financial stocks and defensive sectors consistently underperforming, and growth stocks underperforming value stocks shows strong repeatability across the five cycles, and thus has some reference value.