Rising Interest Rates and the Stock Market

 

When asked what effect oil prices had on the stock market, the late Joe Granville (a colorful newsletter writer and market technician from back in the day) used to have a funny response: “Nooooothing!” he would respond. What about the U.S. dollar? “Nooooothing!” And interest rates? Same answer! His point wasn’t that those factors don’t affect the market at all, of course, but that it’s the market’s own action that you need to pay attention to.

We have been thinking of that story during the past couple of weeks as interest rate mania has taken over the financial press—every economic release and speech by a Federal Reserve governor is scrutinized, with investors wanting to know when the Fed might pull the trigger and raise short-term rates. In response, we’ve seen market interest rates (10-year Treasury yield, shown here) pop higher, while the longer-term yield trend is at least sideways, and it looks like the 40-week moving average might start advancing soon.

But what does this have to do with the stock market? Well, it brings us back to Joe Granville’s response: it turns out that rising market rates, and even periods of tightening by the Federal Reserve, aren’t death knells for the stock market. And, rising rates often coincide with powerful bull markets!

We have seen this in the recent past. In 2011, 10-year Treasury rates fell from around 3.3% to a bit under 2.0% by the end of the year, but the stock market went nowhere. In 2012, 10-year yields remained relatively flat, yet the market rose double digits. In 2013, rates rose from about 2% to 3%, and stocks were up 30%! And last year, yields fell from 3% to about 2.1% and the market did OK, though growth stocks struggled.

But what about the Fed? Well, the central bank started raising rates in early 1999, and the market, of course, soared to crazy heights for another year before rolling over. The next round of tightening began in mid-2004, and the market pushed higher for another three years before the bear market. Prior to 2000, the Fed hiked rates in 1994, which caused the market to chop sideways for most of the year before it soared more than 30% in 1995.

Our point isn’t that higher rates are a good thing; history shows that, eventually, the central bank goes too far, the economy slips into a recession and the bears take control of Wall Street. But, as with many secondary factors like oil prices or currency movements, the link between interest rates and the stock market is far from clear.

Should rates continue to move higher, there are surely some sectors that will take it on the chin. Defensive, dividend-paying sectors, for example, will often struggle as income investors switch to higher-yielding bonds. But growth stocks can often thrive, as money flows to where it’s treated best.

We’re seeing some of this play out now. The Consumer Staples Fund (XLP) is looking ragged, dipping below its 40-week moving average late last week. Meanwhile, the IBD 85-85 Index of growth stocks is perched near its highs and looks ready to get going if the overall market behaves itself.

Long story short, rising interest rates—whether market-based, or set by the Fed—aren’t always a bad thing for the market. And for growth stocks, they can often be a good thing! But the most important point is to keep your eye on what counts—the action of the market and the individual stocks you own and are watching. Right now, the evidence from those areas remains mixed but is improving.

 


Michael Cintolo can be found on Google Plus.

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