Rising bond yields have been a major catalyst for stock price declines over the past year.
But with the market shifting and expecting rates to remain higher than the past decade for longer than many had initially hoped, BMO chief investment strategist Brian Belski notes that higher interest rates haven’t always been a bad environment for stocks.
In an analysis dating back to 1990, Belski found that the S&P 500’s monthly return actually delivered its best average annualized return when 10-year Treasury yields (^TNX) were higher.
Belski’s work shows that the benchmark average delivered an average annual return of 7.7% in months when the 10-year Treasury yield was less than 4%, compared to an average annual return of 14.5% in months when the 10-year return was 6%.
“In a higher interest rate environment, especially higher than 0%-1% or 0%-2%, equities traditionally do very well,” Belski said. “So I think we’re recalibrating that. We still think from these levels, stocks are higher at year-end.”
Belski’s research shows that, on average, shares have performed better in a rising interest rate environment than in a falling interest rate environment. The average one-year annual rolling return for the S&P 500 during a falling interest rate environment is 6.5%, while in a rising interest rate environment it is 13.9%.
He argued that this makes sense since one of the reasons the Fed would keep interest rates low or lower them would be the sluggish economic growth outlook. Given the current environment where the Fed believes the economy is in a strong position to handle higher borrowing costs, higher interest rates may not be so bad for stocks, Belski said.
“If we can float between this 4% and 5% range [on the 10-year Treasury yield] and still have strong employment, but most importantly, have very strong earnings and, by the way, cash flow, I think the market can do very well,” he added.
