Fear not, rising interest rates are just an indication of normalization, according to Morgan Stanley’s Jason Draho.
And it’s not necessarily a bad thing for stocks.
“In fact, the rate rise could simply reflect a catch-up to equity performance after diverging in the spring on growth concerns,” said Draho.
He also addressed the more recent period where we have seen stocks and bonds move together:
“This normalization in rates and its relationship with equities is also evident in the correlation between their returns. Until very recently, the correlation had been negative for almost the entire post- financial-crisis period. The reason was simple: in a risk-off period, equities would sell off while bonds rallied, producing a negative correlation. The recent shift to a positive correlation was due to rates rising while equities fell. This reflects the normalization of policy because the start of tapering is a shift in monetary policy to being less accommodative, and that raises initial concerns about the durability of growth.”
Rising rates will almost certainly add to market volatility.
“In the tightening cycles beginning in 1984, 1994 and 2004, the S&P 500 experienced corrections around 10% in the surrounding months of the first rate hike. Markets remained choppy until investors gained confidence that EPS trends were improving, a pattern we expect to repeat in this cycle.”
Going forward, investors will need to see earnings growth in order to keep pumping up equities, Draho writes.
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