Rising Interest Rates and the Stock Market
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Stocks have been volatile in recent weeks, with high-growth tech stocks leading the decline. At the end of February, the Nasdaq 100 was 7% below its record high, while the S&P 500 was off 4%.
Driving a bulk of the sell-off was not poor corporate earnings, or a grim outlook for COVID-19 and the eventual reopening of the US economy. Those areas have actually seen positive developments in recent months.
Rather, the weakness stemmed from fear over rising interest rates.
The 10-Year US Treasury Note saw its yield spike to 1.60% last week, a substantial increase from the start of the year when it yielded less than 1.00%.
Here's are three reasons why interest rates can have such a sizable impact on stock prices.
1. Low interest rates mean low financing costs. Whether it's a consumer buying a car or house, or a business taking out a loan to expand its production line, low interest rates can help stimulate the economy by encouraging borrowing (and spending).
Therefore, a rise in interest rates can have the opposite effect, as financing costs move higher and make borrowing more cost prohibitive.
2. Declining interest rates means lower rates of return for safe haven assets like bonds. Therefore, stocks tend to look more attractive to investors during periods of low interest rates relative to fixed income.
A common measure to gauge this relationship is the difference between the dividend yield for the S&P 500, and the interest rate on the US 10-Year Treasury note. With the S&P 500 currently yielding 1.50%, and the US 10-year at 1.61% last week, stocks briefly lost their appeal relative to bonds.
3. Rising interest rates typically signal a strengthening economy. And a strengthening economy typically leads to an abundance of growth. With growth less scarce, investors are less willing to pay lofty valuations for high-growth stocks, leading to a decline in richly valued stocks.
The reasons above barely scratch the surface on the relationship between stocks and interest rates, but having a general understanding of this dynamic can help you navigate market volatility when it's driven by a move in rates.
And more often than not, investors are merely throwing a tantrum when interest rates suddenly rise.
Since 1990, the 10 months with the largest yield spikes were met with positive returns in the stock market over the subsequent year, 80% of the time. So don't make long-term investment decisions based on short-term movements in interest rates.
Chart Of The Week
The above chart is remarkable.
Despite surging stock prices over the past decade, cumulative mutual fund and ETF flows have gone mostly into bonds, not stocks.
Since the stock market bottom on March 6, 2009, investors have poured nearly $3 trillion into bonds, and only $133 billion into stocks.
What happens when this trend flips? More than $60 trillion in wealth is expected to transfer to Generation X, Y, and Z over the next few decades, and stocks will likely be where much of this wealth ends up.
As the supply of stocks remains stagnant, or even dwindles as more companies buyback their shares, and as demand increases due to increased investing from younger generations, stock prices will likely move higher.
At Ithaca Wealth Management, we build customized investment portfolios to help you compound your wealth. Reach out today to learn more, or visit www.ithacawealth.com
Your Investments In The News
- Thermo Fisher Scientific increased its dividend by 18%. Danaher increased its dividend by 17%. Waste Management increased its dividend by 6%. Home Depot increased its dividend by 10%. Walmart increased its dividend by 2%. Intercontinental Exchange increased its dividend by 10%.
- Even amid a global pandemic, Amazon and Apple saw record fourth quarter revenues of more than $100 billion for the first time ever.
- Amazon CEO Jeff Bezos stepped down from the company he founded nearly three decades ago. Bezos is being replaced by the head of Amazon's AWS Cloud division, Andy Jassy.
- For the first time since the start of the COVID-19 pandemic, Apple has reopened every one of its US retail stores. The iPhone maker has also been in reported talks with car manufacturers like Hyundai and Nissan, as it looks to replicate the success of Tesla in the coming years.
- Beat fourth quarter earnings estimates: Nvidia, Salesforce, Berkshire Hathaway, Medtronic, Home Depot, Waste Management, Disney, PepsiCo, Cisco, Intercontinental Exchange, PayPal, Alphabet, Amazon, Thermo Fisher Scientific, Honeywell, Eli Lilly, Mastercard, Adobe, Apple, Microsoft, Abbott Laboratories, BlackRock, Verizon, Procter & Gamble, Danaher, Stryker, Starbucks, Intuitive Surgical, Costco.
- Missed fourth quarter earnings estimates: American Water Works, TJMaxx Companies, Merck, McDonald's.
- Walmart beat fourth quarter revenue estimates, but missed earnings estimates. The company unveiled a multi-year plan in which it will reinvest heavily in its business to drive long-term sales growth via automation, ecommerce, and fintech.
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Market Musings And Tidbits
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Thanks for reading, and please reach out with any feedback or questions.
Matthew Fox, CMT, MBA
Founder & Wealth Advisor