02 May Rising Interest Rates. Should Stock Investors Care?
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,
“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.
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