Last November, capital markets were discounting a rate hike five months later, based on Fed Funds futures. Same story today. Last November, the S&P 500 was trading near 2100. Same story today. Last November, VIX levels were around 14. Same story today. Last November, instead of waiting five months, the Fed hiked rates one month later; the S&P dropped by 10% over the next eight weeks... And as BofAML's Savita Subramanian warns, hiking during a profits recession usually hasn't ended well.

Admittedly, other factors contributed to the decline, but history is rhyming, and BofAML thinks a rate hike this summer could drive some downside. While Fed Funds futures prior to mid-May implied little to no chance of a summer hike, the release of the latest FOMC meeting minutes have shifted futures to a 30% probability of a June hike and a 50% probability of a July hike.

Industries could play musical chairs

Is the S&P 500—up 2% since the release of the FOMC minutes—priced for a summer hike? We think not. In fact, industry valuations largely suggest the opposite—the vast majority of “hawkish” industries (which have outperformed when rate hikes have been pulled forward by the market) are still cheap, while most “dovish” industries (which have outperformed when rate hikes have been pushed out) are still expensive (Chart 1).

Tightening during a profits recession rarely ends well

The Fed has only embarked on a tightening cycle during a profits recession three other times, which typically spelled downside for the S&P 500.

Currently, the implied probability of a June hike is 4% vs. 17% in July, 34% in September, 37% in November and 53% in December. Our economists forecast the Fed will hike in September, though they have said that this summer is not off the table.

...and returns are generally muted in "one and pause" cycles

According to our Global Investment Strategy team’s work, “one and done” tightening cycles—where the next action after the initial rate hike was a rate cut—have historically been positive for risk assets, with equities initially rallying 19% in the 12 months after the initial hike.

Meanwhile, in cycles where the Fed has paused one to two quarters between the first and second hike, equities have been in the red over the next three and six months, and were up just 3% in the twelve months following the initial hike.

Five months have already passed since the Fed’s initial rate hike, suggesting returns may remain lackluster if the Fed hikes this summer (or in September, per our economists’ base case).

Five of the seven “one and done” tightening cycles saw the Fed cut rates within three to four months of the initial hike.

The longest the Fed has waited between a first rate hike and a second rate hike has been 21 months (1946-1948), followed by 16 months (1963-1964).

A summer hike is just one of several reasons to worry

As we recently wrote, a rate hike is just one of a number of reasons we are cautious on stocks into the summer, which is already a seasonally weak period for equities. Warning signs have been popping up in various fundamental, behavioral and credit signals that we track. And oil prices - to which equities have been highly correlated - could see another leg down based on our house forecast for a W-shaped recovery; politics at home (US election) and abroad (EU Referendum) suggest potential for volatility in months ahead. And even if the Fed stops tightening, capital markets and lending standards are tightening for them.