Does the negative relationship between stocks and interest rates always hold?
Does the negative relationship between stocks and interest rates always hold? As explained previously, the correlation between stocks and bonds (and therefore interest rates) fluctuates significantly. In the report by Deutsche Bank, strategist Francesco Curto examined the relationship between stocks and bonds in 1994. In 1994, the Fed had kept rates at 3 percent for three years in order to help the economy recover from the savings and loan crisis. Then the Fed unexpectedly raised the Fed funds rate by 25 basis points. Consequently the bond market had its worst year since the late 1920s. How did stocks perform during this time of rising rates?
- The S&P 500 lost 9 percent from February-April 1994 and bond yields rose over 3 percent throughout the year. Following this time period, economic growth picked up, and the S&P 500 rose by 40 percent over the next 14 months and bond yields declined by 2 percent. If economic growth increased to a point – say 2.5+ percent annually – that the Fed felt comfortable decreasing their monthly bond purchases, it does not necessary mean that the stock market is going to perform poorly because of the higher rates.
- A moderate increase in rates could allow for the return to historically more normal rates. This would allow individuals with net savings to receive more interest income from their savings accounts and money market funds. Moreover, banks might become more apt to lend to individuals. Banks receive the spread between what they pay to depositors and what they charge on loans. Since banks typically pay depositors at short-term interest rates and then lend to individuals, businesses, etc. at long term rates, banks tend to be more profitable when the yield curve is steep (long term interest rates are higher than short term interest rates).
- Similar to 1994, recent large interest rate increases have been a negative to stocks in the short term. Investors tend to focus exclusively on the interest rate change rather than the positives that might have helped push rates higher: economic growth, improving employment situation, etc. The 10-year Treasury rate increased by 32 percent in May, but the stock market ended the month in positive territory. Since 2000 there have been two other times when long-term interest rates increased by more than 25 percent in a year, and in both cases stocks fell by at least 5 percent.
The S&P 500 Stock index is a widely recognized, unmanaged index of common stocks. It is not possible to invest directly in an index. Past performance is no guarantee of future results.
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The 1994 Effect. 22 Mar 2011. The Economist. 4 June 2013.
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