Why Stock ETFs and Interest Rates Can Rise Together

ETF Trends

Recent history shows that U.S. equity ETFs and interest rates can actually rise together.

“Conventional wisdom tells us that rising interest rates are anathema to stocks. In recent weeks, the mere suggestion that the Federal Reserve might begin to taper, or reduce, its purchases of long-term Treasury and mortgage securities has been enough to roil the equity markets in anticipation,” S&P Dow Jones Indices said in a recent report.

However, during the multi-decade rally in U.S. Treasury bonds, there have been instances when interest rates and stocks rose at the same time.

“With interest rates at historically low levels, investors might reasonably assume that it’s not a matter of if but a question of when rates will increase. Hence stock market volatility seems to spike with every suggestion of an imminent Federal Reserve action,” according to the report.

Yet there are instances when rates and stock prices can both be driven by the same set of exogenous economic variables.

Since 1991, there have been three periods of rising interest rates, and the S&P 500 rose in all three instances.

“Rising rates have clearly not been bad for stocks over the past two decades,” S&P Dow Jones Indices said.

Yet looking back further, since 1953 rising Treasury yields have been bad for the stock market.

“The data for the past two decades are not consistent with the entire history of the past 60 years. The longer data set tells us that stocks do best when rates fall the most, and vice versa. But this does not seem to be reflected in recent years,” according to the report.

“To what degree should the prospect of Federal Reserve tapering unsettle equity investors? The evidence does not allow a definitive answer,” it concluded. “There are good reasons to believe that the prospective increase in interest rates will be bad for the stock market, and there are good reasons to believe the opposite. If it is true that interest rates and stock prices can both be driven by the same set of exogenous economic variables, it’s arguable that the variables that will lead the Fed to increase rates will also support higher equity prices.” [Stock, Treasury ETFs Look to ‘Taper Lite’]

The opinions and forecasts expressed herein are solely those of John Spence, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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