In my December 15 post THE TRUMP LOVE-IN, I produced a 50-year chart showing how equity markets behaved during periods of rising long-term rates, concluding that
In the 12 periods of rapidly rising long-term rates between 1965 and 1996 (I grouped a few short periods on the chart), not one was accompanied with any meaningful gains in equities while most saw equities perform a really deep dive (average –14.5%).
(…) Since 1996, there were some instances when rising rates coincided with higher equity prices, like in 1998-2000, maybe 2005-06, and 2010. The first two instances saw equity valuations truly explode as investors bought into “great stories”, only to totally deflate when the dreams turned into terrible nightmares.
A few days ago, I stumbled on a similar analysis by LPL Financial, a brokerage with over 14,000 financial advisors and a book of $500 billions, which appeared in a December 12 Weekly Market Commentary and which covered the past 55 years:
The results offer generally good news, as stocks have mostly interpreted rising interest rates as a signal of better economic growth rather than harmful inflation. During the 23 periods analyzed, the average gain in the S&P 500, excluding dividends, has been 5.7% (median 3.8%). The average duration of the periods is 1.06 years and stocks rose in 83% of the periods. (…)
Recent history has been better in general, as stocks have risen in all 11 rising rate periods since 1996, with an average gain of 9% (median 5.4%). These periods have been shorter in duration (average half a year) and seen slightly smaller rate moves, a reflection of the low inflation and low interest rate environment over the past 20 years.
Bottom line, we believe the bull market in stocks can coexist with the bear market in bonds and we interpret the move in rates as an indication of improving economic growth prospects rather than of worrisome inflation.
Same data, very different conclusions on a crucial matter.
Let’s look at the facts, all the facts.
In the following charts, I plot the S&P 500 Index and the 10Yr Treasury yields for each time-frame considered by LPL. The periods measured by LPL are within the red rectangles while the black rectangles cover the periods I find most relevant for a complete, objective and realistic analysis.
For those who would not want to peruse all 16 charts, my conclusion is that:
- Beginning and/or ending dates can make a big difference.
- Chosen periods can influence the analysis.
- Sometimes it is best to consider what happened immediately following the rate peaks. Unsurprisingly, the effects often carry beyond the end date.
- As Mark Twain said, facts are stubborn, but statistics are more pliable.
- I stick with my conclusion: beware rapidly rising long-term rates.
- 1962-1966: LPL starts the period in December 1962 but I consider the 30 bps rise in rates between 12’62 and 06’65 to be inconsequential. The big move began in September 1965 when rates rose from 4.3% to 5.2% in August 1966 (month-end data only). Equities lost 14.4% during these 12 months.
- 1967-1969: there are really 2 periods here, the first producing flat equity markets and the second –17.5% (with a subsequent additional –14.3% through June 1970). LPL began the count mid-March 1967 and ended it December 29, 1969, producing a positive 1.3% return for the whole period.
- 1971-1974: I grouped 2 of LPL’S periods here, which really are 3 for me. Nothing positive.
- 1974-1975: Strangely, LPL starts mid-December 1974 even though rates kept declining through February 1975, and ends mid-September 1975. From 03’75 to 09’75, equities were +2.4%, much different than LPL’s +22.5%.
- 1976-1980: Similar periods except that LPL’s ends Feb. 27, 1980 even though rates peaked end of March 1980. The volatile equities lost 10.5% during March 1980, resulting in a 4.7% loss for the whole period vs +5.1% during LPL’s period.
- 1980-1981: periods concur. Equities flat beginning to end.
- 1983-1984: periods concur. Equities –7.9%.
- 1986-1987: LPL’s period starts August 1986, even though rates staid flat for another 15 months while equities rose. Shockingly, LPL’s analysis stops October 16, 1987, the Friday before Black Monday when the S&P 500 collapsed 20%! How could LPL simply dismiss that? LPL’s analysis: equities +11.8%. My analysis: equities –13.7%.
- 1988: periods concur. Equities +1.0% using LPL’s specific dates. Using my month-end dates: –2.2%.
- 1989-1990: interest rates declined 32 bps after LPL stopped counting in early May 1990. But rates really peaked out in September 1990. Equities cratered 15.7% after LPL closed its books.
- 1993-1994: almost identical periods. Mine ends after rates peaked at the end of November 1994, a month during which equities lost 3.8%.
- 1996: LPL’s period: equities +6.7%. But equities lost 4.6% in July 1996.
- 1998-2000: identical periods. Equities up 45.8% to reach their most expensive levels of the 20th century. BTW, equities peaked in August 2000 and went on to deflate 20% before reaching the next chart…
- 2001-2002: technically, rising rates did not hurt equities during LPL’s specific period…but if you elected to stay in after the first 20% setback (above), this last rate burst terminated you…
- 2003-2006: I grouped 3 LPL periods on the same chart. Periods concur. Equities + 3.8%, +1.3% and + 3.6%. Risk vs reward???
- 2008: LPL breaks this period in two. In the mean time, peak to trough: –47.5%! Can’t miss a beat, can you?
This is how LPL summarizes its analysis:
A casual observer can only conclude that higher rates are clearly positive for equities. I wish LPL clients all the best for 2017. They may think they have a strong edge. But with really poor odds, they better hedge.
Unless this is the new normal because, maybe, this time is different. The last 3 spikes in LT rates did not stop equities:
But this time is no different. Rising rates are not good for indebted governments, companies and individuals and not good for equities based on common sense backed by 55 years of data analysed objectively. Rising interest rates bring the sea level down, exposing all naked swimmers. There currently are quite a few of these out there…
Finally, if you are wondering what rising short term rates can do to equities, the complete, objective analysis is here: EQUITIES AFTER FIRST RATE HIKES: THE CHARTS SINCE 1954. Here’s the conclusion:
To be brief, in layman’s terms, in reality, there seems to be no consistent nor typical pattern after the first rate hikes.
However, digging a little more into the history book, I found that in 6 of the 8 years when the S&P 500 rose during the initial rate hike, inflation was actually diminishing or stable (2004). This did not verify in 1987, although the market eventually avenged itself and in 1999 when internet speculation blinded everybody.
Maybe we got ourselves a bit of a rule here: rate hike cycles are not damaging to equities in as much as inflation is not rising at the time. Since profits are generally still rising when the Fed takes its foot off the pedal, stable or declining inflation rates help sustain P/E ratios as demonstrated by the Rule of 20.