Interest rates have been on the rise in recent months. At 2.26% today, the 10-year US Treasury note yield is way up from its January 30 low of 1.63%.
But are rising interest rates bad for stocks? It might seem so. After all, higher rates mean higher borrowing costs for corporations.
However, history suggests otherwise.
“We note that since 1998, changes in bond yields and equity performance have been positively correlated, (i.e. equities and bond yields have risen together), as we can see below,” Credit Suisse’s Andrew Garthwaite said in a note to clients on Friday.
There are a few theories to justify this trend.
“[T]ypically a rise in inflation expectations is positive for equities (with equities being an inflation hedge) when inflation expectations rise from sub 2% to over 2%,” Garthwaite added. Keep in mind, the stock market includes companies like Wal-Mart, Apple, and ExxonMobil, all companies that pass inflation to their customers and receive right back for their investors.
In his note to clients on Friday, BMO Capital Markets Brian Belski also discussed this relationship between rising rates and rising stock prices. He explained that rising rates are actually sign of good things to come.
“[S]ome of the best and most consistent average returns have occurred when interest rates have risen from very low levels — as is currently the case,” Belski said. “From our perspective, this means that the bond market is correctly anticipating future economic growth and staying ahead of inflation — things that typically benefit stock prices.”
Reviewing the data since 1985, Belski found that the least favourable interest environments for stocks were when rates were low, below average, and declining.
“This makes sense to us since lower interest rates are typically reflective of sluggish economic growth and vice versa,” he said.
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