• What is the relationship between interest rates and the stock market?
• Can stocks rise in a rising interest rate environment?
• Do interest rates impact all stocks the same?
Logic, and recent stock market volatility, would seem to suggest an inverse relationship between interest rates and stock valuations. Interest rates have been low for many, many years (until recently the long term government bond yields were 2% or less) making bonds less competitive than stocks. This is particularly so for dividend paying stocks, making stocks the obvious investment class of choice. However, rates are now rising on fixed income securities, and logic might then seem to suggest that stocks will become less attractive versus bonds.
A look at past events is often instructive when considering how to analyze and make current investment decisions. Here are historical examples (from most of our lifetimes) that show the reality of rising interest rates and the concurrent effect on the stock market:
- 1960s: S&P 500 went up, nearly doubling during the last eight years, while interest rates were slowly climbing during that entire period.
- 1970s: S&P 500 was mostly flat while interest rates were rising for large periods of this decade. There were other negative economic influences on growth during this period, namely the energy crisis, stagflation and the general “malaise” that was prevalent during this decade.
- 1980s: S&P 500 was generally flat during pockets of rising interest rates during this decade. Most of us can recall the tremendous overall growth in stocks during the 1980s, a period in which the S&P 500 tripled.
- 1990s: S&P 500 was flat (or some- times rising by quite a bit) for periods during the mid and late 90s. Though, overall the S&P 500 grew by over 4 times!
- 2000s: S&P 500 rallied consistently during a 3 year period in the middle of the decade, and (specifically isolating for when rates were rising) a 1 year period at the end. Interestingly, even though stocks made money during these rising interest rate periods, the S&P, overall, was down for the decade.
- 2010s: So far, the S&P 500 has grown during this current decade, by 2.5 times. Further, there have already been two periods of rising rates, and each time the S&P 500 rose at the same time.
There is certainly some randomness to these tandem movements of stocks and rising interest rates, but there are more times than not, in the last 50 years or so, where the S&P 500 went higher while interest rates were also rising. One economic condition that contributes to increased stock values during rising interest rate periods is lower inflation, which we currently observe. This positive effect also has been seen to extend to the year following the start of rising rates. While evidence does exist showing stocks falling during certain periods when rates are rising this condition is more prevalent when inflation is higher than 4%, as it was in the 1970s.
As every cycle is of course unique, we should look to the overall condition of the economy, as well as specific companies, as the better correlating factor to increasing investment values, particularly in U.S. stocks. Additionally, where here in the U.S. we are currently in this rising interest rate environment, we are keenly aware that there may well be better investment opportunities elsewhere throughout the world. Where certain interest rate sensitive sectors in the U.S. stock market are under more pressure than those less dependent on lower interest rates, foreign economies could outpace domestic returns, and we will look to diversify and allocate our investments appropriately.
Rising interest rates will trigger short term volatility and possibly short term declines in stocks as we have seen (in the short run) recently. At BWFA we will always look to broader economic conditions, which today are still quite good, as well as the stock market movements, in utilizing a long term perspective when assessing our investment decisions for our clients.
Joseph Manfredi | MBA | Chief Operating Officer / Senior Portfolio Manager | jmanfredi@bwfa.com