Yellen and Company will meet today and tomorrow to assess any policy changes. This will be the last meeting before the October meeting during which the cessation of QE is expected. Inflation doesn't appear to be a major threat at the moment so the Fed has some leeway in deciding when it is finally time to raise rates. Moving away from ZIRP should ultimately be a good sign as it indicates a belief in sustained economic improvement, but I doubt the Fed will be hasty. The last thing Yellen wants to be remembered for is tanking the economy by tightening too quickly. Based on prior comments, it seems likely that the Fed will move slowly unless their hand is forced by sharply increasing wage growth or price levels.

Rate hikes, when they do finally begin, will lead to increased volatility in the markets, but remember that historically stocks do fine during the initial phases of rate increases. Back in June I discussed some analysis performed by Oliver Purshe. He found that since 1980, the Fed has raised interest rates 67 times and in 90% of the those cases, the S&P was higher two years later. So Fed tightening does not necessarily mean disaster or an end to this long-winded bull market.

Goldman put out some research that may help us understand what to expect on a shorter-term basis regarding rate increases. They looked at the last three times the Fed began raising rates (1994, 1999, 2004) to see how stocks behaved before and after those rate moves. I consolidated their findings into the table below:

As you can see, in all cases the S&P averaged positive returns except for immediately following the initial rate hikes.

This data passes the common sense test, at least in my opinion. The Fed only increases rates in response to improving economic conditions. Thus, you would expect to see positive gains in the run-up to initial rate hikes because of a strengthening economic backdrop. Then, after an emotional short-term reaction and sell-off, the positive economic inertia built up during the low rate environment carries forward, bringing equity prices with it 6 months and 12 months down the road.

This information may also help to set expectations of market performance between now and the first rate increase. If we go with the assumption held by most economists that the Fed will begin raising rates in early to mid-2015, that leaves us a little over six months away. Based on the historical data above, that suggests we may see something around 7% appreciation between now and then. But as always, past performance is not ... ah heck, you know how the rest of that statement goes.

Related:

Jim Puplava's Big Picture: Be Prepared - Rate Hikes Are Coming

The above content was an excerpt of Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.