The recent sell-off in the Treasury market has economists and analysts on watch for the impact of higher interest rates.
There are two ways to think about rising rates: 1) It’ll cause borrowing costs to rise, which will hurt the economy and squeeze corporate profits. Or 2) It’s a sign of a strengthening economy, which means inflation will pick up and investors will seek riskier assets than bonds.
The analysts at Deutsche Bank subscribe to that latter view, and they believe rising rates are probably good news for stocks.
“Since 2000, rising bond yields have mostly been associated with rising equity markets,” writes Deustche Bank in the its Equity House View report. “Even sharp rises in bond yields have overwhelmingly coincided with positive equity returns (88% of instances).”
Here’s DB’s chart showing the positive correlation between stocks and interest rates since 2000.
In a May 7 note to clients, Deutsche Bank strategist Francesco Curto took a close look at what happened with stocks when interest rates surged in 1994.
“The best term of reference for assessing what may happen to equities and bonds in the near future may be the 1994 dynamics in both equities and bonds, according to some observers,” wrote Curto. “Strong economic growth, with little inflation, makes the 1994 comparison with the current situation relevant”
More from Curto:
…In fact, after the autumn 1994 peak in bond yields we saw a significant rise in the level of the S&P 500. We are also of the opinion, provided that inflation expectations remain anchored, that a rise in bond yields will not precipitate another equity market crash in the near future. It is a risk that no central bank or politician can take. We believe that central banks are more willing to accept moderate inflation than the risk of a new equity crash.
Here’s Curto with more detail:
A three-stage analysis of the 1994 sell-off from an equity perspective
The equity market response to the 1994 bond sell-off is best analysed through a threestage model.
Stage 1 (falling bond yield): June 1991 to Sept 1993. In this period, the S&P 500 went up 24% (from 371 to 459) and 10-year bond yields went from 8.23% to 5.38%. Financials, Telecoms and Utilities were the best-performing sectors.
Stage 2 (bond sell-off): Sept 1993 to Nov 1994. The S&P 500 went from 459 to 454 and bond yields from 5.38% to 7.91%. The S&P 500 lost 8.9% between 2nd February and 4th April before recovering. Utilities, Financials and Telecoms performed the worst; whilst IT, Healthcare and Staples did best.
Stage 3 (falling bond yield): Nov 1994 to Jan 1996. The S&P500 went from 454 to 636 and bond yields from 7.91% to 5.58%. Health Care, Financials, IT and Industrials were the best performing sectors. Telecoms and Utilities rallied, but not enough to offset their losses from Stage 2.
Of all of the things that should have stock market investors worried, perhaps rising interest rates shouldn’t be one of them.
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