Ignore The Hype: Here’s What Interest Rates Are REALLY Telling You About The Future Of Stock Prices

Posted On May 17, 2018 2:37 pm

Rising Rates Are Good For Stocks

JPMorgan did a study looking at the correlation between stocks and the 10 year yield since 1963. They found that there is actually a positive correlation between total returns and interest rates.

Now it’s true that rates that are too high can and do stifle the economy, earnings growth, and stock prices. BUT that doesn’t start to happen until 10 year yields go north of 5%. Below that rising rates are good for stocks. Ok so maybe a roaring economy is good for the market as a whole but surely it would be bad for high-yield stocks like REITs and MLPs right? After all these are bond proxies.

Actually Blackrock, the world’s largest financial asset manager, looked at how different sectors did since 1995, broken down by yield curve regime. That means they looked at both whether or not rates were rising (bearish in the common view) or falling (bullish). They also looked at whether the yield curve (difference between long-term rates and short-term rates) was rising (steepening) or falling (flattening).

As you can see the best time for most stock sectors has been in a bearish steepening regime, when rates are both going up AND long-term rates are rising faster than short-term rates. Fundamentally this is because it means the economy is stronger AND financial companies (like banks) make more money (borrowing at short-term rates and lending at higher rates).

More profitable lending means more lending volume, and so more greater spending by consumers and businesses (for investment). So such an interest rate environment means a strong economy and rising corporate profits rise and every sector does well. What about when rates are rising but the yield curve is falling? That would be a bear flattening regime which is what we have now. Lending becomes less profitable but the economy is still growing and so earnings rise and stocks do well but less so. REITs and MLPs (energy) also do well, despite what the “rates up, high-yield stocks down” bond proxy meme would have you believe.

The bottom line is that if interest rates are rising this is good for stocks, because it likely means the bond market is bullish on the economy. And if long-term rates are rising faster than short-term rates? Then it means the bond market is VERY bullish on the economy. Better yet that rising yield curve means that lending becomes more profitable and so that bullishness becomes a self fulfilling prophecy. One that leads to even stronger growth for longer, which is ideal for stocks.

But even if the yield curve doesn’t rise (just stays at current levels) the current interest rate environment is one that is still likely to prove profitable for your portfolio. Assuming you can stay calm, take the long-term (fundamental) view and ignore the media’s doomsday hype. Remember bearish forecasts about how rising rates will crush stocks are designed to get your attention and sell ads, not actually help you invest better.

Photo: “Wall Street” by Alex E. Proimos is licensed under CC BY-NC

About author

Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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