Rising Bond Yield Implications

March 05, 2021

Are Rising Interest Rates Good or Bad for the Stock Market?

U.S. interest rates were the talk of the Street last week as expectations for an economic rebound pushed the 30-year Treasury yield above 2% for the first time since the pandemic began. What does this mean for Stocks? Why Are Yields Rising?

  1. Hope that the vaccination program is working
  2. Anticipation of more stimulus spending by the Federal Government
  3. Expectations of a strong economic recovery

What are the Risks?
Despite the positive signal from rising yields that the economic recovery is gaining traction, higher yields can eventually have negative consequences for markets, including:

  1. Inflation: A pickup in inflation could eventually lead the Federal Reserve to raise short-term interest rates, a potential negative for equities.
  2. A hit to growth stocks: Growth stocks can eventually be hit hard as their sky-high earnings multiples contract due a reduction in the present value of their future earnings caused a higher discount.
  3. Earnings declines: should interest rates rise too far, corporate earnings will be negatively impacted as borrowing costs rise.

Stocks that may benefit from rising interest rates (many of which we currently own):

  1. Banks & Insurance Companies: higher interest rates allow them to earn more on their loans and bond portfolios.
  2. Industrials, Basic Materials, Energy: the economic recovery benefits demand for their products and services.
  3. Dividend-payers: the economic recovery alleviates concerns over dividend cuts.
  4. Value stocks: value companies stand to benefit more than growth companies as their earnings rebound and their earnings multiples compress less than much higher multiple growth companies.

Our Perspective
The “re-setting” of interest rates following a recession is a normal process. Initial concerns over rising rates can cause minor stock pullbacks (5-10%), but they have not historically derailed the bull market. As shown below, when interest rates rose in 2013 (from 1.6% to 3.0%), the S&P 500 posted a 32% gain for the year, overcoming three intra-year pullbacks of 4-8%. Over the past 12 years, the S&P 500 has gained 19% on average during rising interest rate backdrops.

^SPX Chart

^SPX data by YCharts


We believe it’s important to keep the current absolute level of rates in perspective. As of Friday’s close, the 10-yr Treasury yield of 1.4% remains extremely low from a historical perspective and has yet to surpass the pre-pandemic level around 1.9%. Using the past 12 years as a guide, the 10-yr Treasury yield would have to rise well above 3.0% to derail the bull market. While we believe the bull market for stocks
has further to run, we will continue to let the “weight of the evidence” guide our investment discipline. Should key risk metrics reach defensive trigger levels or higher interest rates show greater negative consequences for stocks, we will adjust accordingly.

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