Rising bond yields have been a key catalyst for stock drawdowns over the past year. But as the market shifts to expect that interest rates may remain higher than the previous decade for longer than many initially hoped, BMO chief investment strategist Brian Belski notes that higher rates haven’t always been a bad environment for stocks.
In an analysis spanning back to 1990, Belski found that the S&P 500’s monthly return has actually delivered its best annualized average returns when the 10-Year treasury yield was higher. This challenges the conventional belief that rising interest rates are detrimental to stock performance.
Belski’s work shows that when the 10-year Treasury yield was less than 4%, the benchmark average delivered an average annual return of 7.7%. However, in months when the 10-year yield was 6%, the average annual return was 14.5%. This suggests that in a higher interest rate environment, stocks traditionally perform well, contrary to popular belief.
Furthermore, Belski’s research indicates that stocks have historically performed better in a rising rate environment than in a falling rate environment. During a falling rate environment, the average annual rolling 1-year return for the S&P 500 is 6.5%, whereas in a rising rate regime, it is 13.9%. This highlights the correlation between higher interest rates and stronger stock performance.
One reason the Federal Reserve would keep rates lower or cut them is a sluggish economic growth outlook. However, given the current backdrop where the Fed perceives the economy to be in a strong position to handle higher borrowing costs, increased rates might not be so bad for stocks. Belski argues that as long as the 10-Year Treasury yield stays within the 4% to 5% range and there is strong employment, earnings, and cash flow, the market can thrive.
These observations raise interesting implications for the future trends and investment strategies. As interest rates continue to rise, investors should consider the potential benefits of holding stock investments. While caution is always necessary, history has shown that higher rates can be compatible with a flourishing stock market.
In the current economic landscape, it is crucial to closely monitor the actions of central banks, particularly in relation to interest rate policies. As the global economy recovers from the impact of the COVID-19 pandemic, central banks may gradually tighten monetary policies to curb inflationary pressures. This could lead to a further increase in bond yields and subsequently impact stock markets.
Additionally, the correlation between rising interest rates and strong stock performance indicates that investors should focus on sectors that tend to thrive in higher interest rate environments. Industries such as financials, technology, and consumer discretionary may present opportunities for growth and profitability.
Furthermore, geopolitical factors, such as trade tensions and political instability, can also influence interest rates and subsequently impact stock markets. Keeping a close eye on global events and their potential repercussions on interest rates is crucial for investors seeking to make informed decisions.
In conclusion, while rising bond yields may initially be perceived as a cause for concern, historical data suggests that higher interest rates can actually benefit the stock market. As we navigate the post-pandemic economic recovery and potential policy changes, investors should consider the implications of rising interest rates and adjust their investment strategies accordingly. By staying informed and understanding the relationship between interest rates and stock performance, investors can position themselves to take advantage of potential future trends and maximize returns.