The Federal Reserve has been quite aggressive in its fight against inflation. Officials approved 11 rate hikes during the 12 meetings between March 2022 and July 2023, raising the benchmark federal funds rate at its fastest pace since the early 1980s. But the abrupt change in monetary policy made investors nervous as overtightening could easily bring about a recession. That fear sent the S&P 500 tumbling into a bear market early last year.
However, investor sentiment has improved greatly in recent months amid signs of economic resilience. Inflation fell to 3.0% in June (closing in on the Fed's 2% target), and U.S. GDP growth accelerated in the first and second quarters. That positive data helped the S&P 500 rebound sharply from its bear-market lows, and the broad-based index is now less than 5% away from a fresh all-time high. Reaching that mark would definitely signal a new bull market.
But history says the S&P 500 is headed even higher in the next year.
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The S&P 500 could soar once the Fed's rate hike cycle ends
Chairman Jerome Powell says the Fed will assess the need for further credit tightening on a meeting-by-meeting basis, but most investors believe the rate hikes have ended. Derivatives markets currently reflect an 80% chance that rates remain unchanged at the September meeting and a 25% chance that rate cuts occur by Jan. 2024, according to CME Group's FedWatch Tool.
So what? The S&P 500 tends to rise sharply once the federal funds rate settles. Indeed, the Fed has spearheaded six other rate hike campaigns since 1988, and the S&P 500 returned an average of 23.7% during the one-year period immediately following the last rate hike in each campaign. In other words, if the current rate hike cycle has ended, history says the stock market could climb much higher in the next 12 months.
Investors looking to capitalize on that possible upswing have plenty of good options, but Amazon (AMZN 3.43%) stock looks particularly attractive at its current valuation.
Amazon has three monster growth opportunities
Amazon is one of just six companies worth more than $1 trillion. But its strong presence in e-commerce, cloud computing, and digital advertising -- three quickly growing markets -- should propel its market capitalization much higher in the years ahead. And the stock looks particularly compelling at 2.6 times sales, a discount to the five-year average of 3.5 times sales.
Amazon operates the most visited e-commerce marketplace on the planet, and its immense brand authority should keep the company at the forefront of the industry for years to come. But success in retail has also led to success in digital advertising. Amazon has a somewhat unique ability to engage consumers and collect shopper data, and that ability has helped it become the third-largest adtech company in the world.
Finally, Amazon Web Services (AWS) is the undisputed leader in cloud computing. The tech titan has a broader and deeper product portfolio than any other provider, and it accounted for 34% of cloud infrastructure and platform services sales in the second quarter, meaning AWS holds more market share than Microsoft Azure and Alphabet's Google Cloud combined.
So what? The e-commerce, cloud computing, and ad tech markets are expected to grow by roughly 14% annually through 2030, so Amazon could grow revenue at least that quickly during that same period. If that happens, the stock could return 14% per year through the end of the decade without any change in its already reasonable price-to-sales ratio, and returns of that nature would almost certainly beat the benchmark S&P 500.
The S&P 500 has been a smart investment throughout history
While I believe wholeheartedly that Amazon can beat the market in the coming years, investors looking to take on less risk should consider an S&P 500 index fund like the Vanguard S&P 500 ETF (VOO 1.00%). It tracks hundreds of large-cap U.S. stocks from all 11 market sectors, allowing investors to spread capital across many of the most influential businesses in the world.
That diversity makes the Vanguard S&P 500 ETF a safer investment than most individual stocks. Indeed, Warren Buffett has often recommended an S&P 500 index fund because the index itself is a "cross-section of businesses that in aggregate are bound to do well."
Whether the S&P 500 is up or down in any given year is a coin toss, but the odds of a positive return increase as the holding period lengthens. The S&P 500 has been a profitable investment over every rolling 20-year period since its inception in 1957, and its precursor was a profitable investment over every rolling 20-year period since its inception in 1926.
