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Rising Interest Rates. Should Stock Investors Care?

| May 02, 2018
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Long-term interest rates have been steadily increasing for much of the last six plus months as the global economic expansion has progressed and signs of building inflation pressures have begun to surface. The yield on the 10-year U.S. Treasury note recently topped 3% for the first time in more than four years—a feat which has garnered much media attention and resultant speculation about what the recent move means for investors going forward.

A recent article in the Wall Street Journal article read “It is a climb with significant implications for financial markets. The 10-year yield is a barometer that influences borrowing costs for consumers, corporations and state and local governments. Its half-percentage point climb to similar heights earlier this year contributed to the tumble in the Dow Jones Industrial Average in February, as higher yields dented investors’ confidence that stock valuations could rise unceasingly.”

So, should investors be concerned about the rise in rates above the psychologically important 3% threshold?

Research recently published by LPL Financial suggests that rather than fear rate rises from low levels such as those that have persisted over much of the last decade, investors should welcome them. LPL examined periods during which the 10-year yield experienced a sustained rise over the last 50+ years and concluded that “stocks and bond yields historically have been positively correlated until the 10-year yield gets up around 5%, at which point the correlations break down.” Put differently, when starting from a low initial yield, stocks and bond yields have historically tended to rise together.

The table below, from LPL, shows that during the last 23 periods of sustained rate rises, as measured by the 10-year yield, stocks have delivered positive returns more than 80% of the time, including during each of the last 11 instances of rising rates since 1996.

 

While it’s always entirely possible that “this time is different” and that rising rates will lead to or coincide with stock market declines (after all, in investing, unlike physics, there are no immutable laws), we nonetheless believe that empirical study of the past provides us with good guideposts by which we can derive some modest insight as to what the future may hold. We view the recent rise in interest rates as entirely natural in an environment where the Federal Reserve is working to normalize monetary policy during an ongoing economic expansion marked with robust corporate profitability. The recent rise in rates from a very low level to a slightly higher, yet still low level does not in and of itself pose an imminent threat to either the economic expansion nor to corporate health.

Please reach out to us with any questions you have or if you'd like to talk about your personal financial situation,

Kathmere Capital 

SOURCES

 “Yields on 10-Year Treasurys Cross 3% Threshold” The Wall Street Journal. April 24, 2018.

“Myth Busting” LPL Research Weekly Market Commentary. April 23, 2018.

IMPORTANT DISCLOSURES

Past performance is no guarantee of future results. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. All performance referenced is historical and is no guarantee of future results. No strategy assures success or protects against loss. The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Stock investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price. Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate. S&P 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Private Advisor Group, a Registered Investment Advisor. Private Advisor Group and Kathmere Capital Management are separate entities from LPL Financial.

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