Every year seems to bring unpredictable story lines in the stock market. This year the big story line looks like it’s going to be in the bond market. Interest rates, as measured by the 10-year Treasury yield, have risen to their highest level in more than a year. What’s more, it’s the velocity of the rise that has garnered the most attention. The 10-year Treasury note came into the year yielding 0.95% but is currently yielding 1.60%. This has many economic impacts, but we’re going to save that discussion for a more in-depth article next month. The most basic thing to understand right now is that interest rates are rising.
What’s it mean for stocks?
Contrary to some of the usual fear-mongering in the financial media, higher interest rates haven’t generally stopped the stock market from rising. In fact, it’s been just the opposite; historically, rising interest rates have coincided with a rising stock market:
LPL financial looked at data back to 1962 and found that, on average, rising interest rates have coincided with a rising stock market 78.6% of the time. The average and median returns for the S&P 500 in all instances has been 17% and 15%, respectively. And the average and median 10-year Treasury yield was 2.90% and 2.40%. With the 10-year yield currently around 1.60%, history suggests interest rates could climb further and still be in the “positive for stocks” ball park.
Analyzing the data further
One thing to notice about the data are the recent starting points for the rise in rates. Interest rates are often bottoming near the end of a downturn in the global economy. This is evidenced by the periods above such as December 2008 (Great Financial Crisis), July 2012 (Euro bond crisis), July 2016 (BREXIT), and March 2020 (Covid Crash). This makes sense from an investing perspective: investors buy bonds during times of economic uncertainty and sell them when their confidence in the economic outlook grows. Interest rates move inversely to bond prices.
So it makes sense that interest rates are rising right now, given optimism about the reopening of the economy and vaccination roll outs that are underway. And while the media has been doing their best to use rising interest rates as a scare tactic for investors, the data suggests there’s not really anything to be afraid of.
Lastly, it’s important to note that we are referring to interest rates in the Treasury market (specifically, the 10-year note), and NOT the federal funds rate which is set by the Federal Reserve. Investors must understand that the fed funds rate is a benchmark rate that has a greater impact on commercial banks than it does individual consumers. We’re going to cover this topic in much greater detail in a follow-up post next month. For now, just know that rising interest rates are not the bugaboo the media may make them out to be.
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