Effect of a US Federal Reserve rate hike on the Dow Jones Industrial Average There is speculation that the Federal Reserve of the United States will raise interest rates by 0.25% in the near future. What is the expected effect on the stock market if interest rates do rise by that amount? More specifically, what is the predicted effect on the Dow Jones Industrial Average?
Each component of the Dow Jones Industrial Average (DJIA) has a yield, computed as the earnings divided by the price, expressed as a percentage. For example, if a stock is priced at $100.00 and yearly earnings of $10.00 per share, then the yield for that stock is

yield = earnings / price = $10.00 / $100.00 = 10%


That yield could be paid out as a dividend, or retained and reinvested to grow the company, doesn't matter to this analysis. 

The first step in the analysis is to determine the yield for each of the 30 components of the DJIA. On August 18, 2015 the DJIA closed at 17511.34, and the yields for the component companies were

    Company     Price Earnings  P/E  Yield
Visa            74.47   2.16   34.5  2.90%
Microsoft       47.27   1.46   32.4  3.09%
Nike           114.82   3.70   31.0  3.22%
Procter         75.13   2.44   30.8  3.25%
HomeDepot      122.80   4.71   26.1  3.84%
Coca-Cola       41.30   1.60   25.8  3.87%
WaltDisney     106.94   4.26   25.1  3.98%
Pfizer          35.52   1.42   25.0  4.00%
UnitedHealth   125.50   5.70   22.0  4.54%
McDonald's     100.76   4.82   20.9  4.78%
3M             148.31   7.49   19.8  5.05%
Verizon         47.46   2.42   19.6  5.10%
Boeing         144.60   7.38   19.6  5.10%
Johnson         99.37   5.70   17.4  5.74%
GE              26.07   1.50   17.4  5.75%
Cisco           28.25   1.73   16.3  6.12%
Merck           59.66   4.07   14.7  6.82%
AmExpress       81.24   5.56   14.6  6.84%
UnitedTech      99.41   6.82   14.6  6.86%
WalMart         69.48   5.05   13.8  7.27%
DuPont          53.90   3.92   13.8  7.27%
Apple          116.50   8.66   13.5  7.43%
Caterpillar     78.82   5.88   13.4  7.46%
IBM            156.01  11.90   13.1  7.63%
JPMorgan        68.21   5.29   12.9  7.76%
Intel           28.91   2.36   12.2  8.16%
Goldman        201.18  17.07   11.8  8.48%
Exxon           77.90   7.60   10.3  9.76%
Travelers      107.82  10.70   10.1  9.92%
Chevron         83.44  10.14    8.2 12.15%


The next step in the analysis is to determine the adjusted yield after the Federal Reserve increases the interest rates by 0.25%.

The expectation is that the market will adjust prices to increase yields by 0.25%. In other words, market yields represent a premium above the Federal Reserve rate.   

So for example, the yield on Visa must increase from 2.90% to 3.15% to compensate for a 0.25% increase in the Federal Reserve rate. Given earnings of $2.16, the price must drop from $74.47 to $68.56 (a 7.9% drop) to compensate for the rate increase.  At the other end of the scale, the yield on Chevron must increase from 12.15% to 12.40%. Given earnings of $10.14, the price must drop from $83.44 to $81.76 (a 2% drop).

We can now augment the previous table to include the adjusted yields, adjusted prices, and the drop in price as a percentage of the original price.

                                                  Adjusted    Price
    Company     Price Earnings  P/E  Yield     Yield   Price  Change
Visa            74.47   2.16   34.5  2.90%     3.15%   68.56  -7.94%
Microsoft       47.27   1.46   32.4  3.09%     3.34%   43.73  -7.49%
Nike           114.82   3.70   31.0  3.22%     3.47%  106.55  -7.20%
Procter         75.13   2.44   30.8  3.25%     3.50%   69.76  -7.15%
HomeDepot      122.80   4.71   26.1  3.84%     4.09%  115.29  -6.12%
Coca-Cola       41.30   1.60   25.8  3.87%     4.12%   38.80  -6.06%
WaltDisney     106.94   4.26   25.1  3.98%     4.23%  100.62  -5.91%
Pfizer          35.52   1.42   25.0  4.00%     4.25%   33.43  -5.89%
UnitedHealth   125.50   5.70   22.0  4.54%     4.79%  118.95  -5.22%
McDonald's     100.76   4.82   20.9  4.78%     5.03%   95.76  -4.97%
3M             148.31   7.49   19.8  5.05%     5.30%  141.31  -4.72%
Verizon         47.46   2.42   19.6  5.10%     5.35%   45.24  -4.67%
Boeing         144.60   7.38   19.6  5.10%     5.35%  137.85  -4.67%
Johnson         99.37   5.70   17.4  5.74%     5.99%   95.22  -4.18%
GE              26.07   1.50   17.4  5.75%     6.00%   24.98  -4.16%
Cisco           28.25   1.73   16.3  6.12%     6.37%   27.14  -3.92%
Merck           59.66   4.07   14.7  6.82%     7.07%   57.55  -3.54%
AmExpress       81.24   5.56   14.6  6.84%     7.09%   78.38  -3.52%
UnitedTech      99.41   6.82   14.6  6.86%     7.11%   95.91  -3.52%
WalMart         69.48   5.05   13.8  7.27%     7.52%   67.17  -3.33%
DuPont          53.90   3.92   13.8  7.27%     7.52%   52.11  -3.32%
Apple          116.50   8.66   13.5  7.43%     7.68%  112.71  -3.25%
Caterpillar     78.82   5.88   13.4  7.46%     7.71%   76.26  -3.24%
IBM            156.01  11.90   13.1  7.63%     7.88%  151.06  -3.17%
JPMorgan        68.21   5.29   12.9  7.76%     8.01%   66.08  -3.12%
Intel           28.91   2.36   12.2  8.16%     8.41%   28.05  -2.97%
Goldman        201.18  17.07   11.8  8.48%     8.73%  195.42  -2.86%
Exxon           77.90   7.60   10.3  9.76%    10.01%   75.95  -2.50%
Travelers      107.82  10.70   10.1  9.92%    10.17%  105.17  -2.46%
Chevron         83.44  10.14    8.2 12.15%    12.40%   81.76  -2.02%


The adjusted DJIA computed from the adjusted prices is 16747.96. Thus, the DJIA was expected to drop from 17511.34 to 16747.96 (a 760 point 4.4% drop) to compensate for a 0.25% increase in the Federal Reserve rate.

What actually happened was the DJIA dropped to a low of 15666.44 low on August 25, 2015 (an 1840 point 10.5% drop) before recovering to a range between 16300 and 16500, slightly below the expectation.