For the past several months, the biggest investor concern is related to higher interest rates. But how do interest rates and equities relate usually? Let our expert John Plassard tell you more about this subject in today’s video.
Good morning and welcome to Weekly Insights with John Plassard.
For the past several months, the biggest investor concern is related to higher interest rates.
But history suggests that this apprehension may be a little overblown.
While higher interest rates frequently result in dramatic sector rotations and can momentarily disrupt stock values, historically higher rates have been linked to higher, not lower, stock prices.
To start it's vital to highlight that the empirical relationship between rates and equities is more nuanced than textbooks claim.
Higher interest rates should, in theory, result in lower stock prices because you can discount future cash flows at a higher rate.
It is true that there have been times in the past when higher rates were accompanied by lower valuations and subpar returns, most notably in the 1970s and the early 1980s.
Having stated that, when rates are extremely low, the link between rates and stocks alters.
The relationship between interest rates and valuations has been less clear at the current levels.
At least historically, when rates are rising from low levels, as they are now, stock valuations have been more likely to increase than decrease.
If you refer to BlackRocks data, since 1995, the S&P 500 has produced a price gain of 3.2% over the subsequent three months, or around 100 basis points (bps) more than a typical month, in months where the U.S. 10-year treasury yield increased by more than 50 basis points (bps).
The arguments for a joint development of equities and interest rates become even clearer when valuations are compared with real interest rates, i.e. interest rates minus inflation expectations.
In short, despite the upcoming central bank hikes, the reverse link to equities may not be as obvious as it seems...
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