What do Stocks do when Interest Rates Rise?

April 1, 2018 — Leave a comment

Quiz!

In the past 20 years, how did Extended-Term Component perform in a period of rising rates from low rates?

  1. It gained more often than declined.
  2. It declined more often than gained.
  3. It gained consistently in all cases.
  4. It declined consistently in all cases.
  5. As with most things, the results were mixed.

What do Stocks do when Interest Rates Rise?

This article reviews the impact of rising rates from a low point on the high-volatility high-growth stock portfolio Extended-Term Component, both empirically and logically.

Empirically: We have 2 cases of rising rates from a low point in the live history since 1998:

Increase Date

Starting Rate

Trend information

Performance since rate increases started

Duration

Rates before peak portfolio

6/30/2004

1%

Gain started 1.5 years earlier

+277%

3.3 years

Reduced for a month after plateaued for over a year

12/17/2015

0%-0.25%

Gain started after a short-lived (35 days) 12% decline

+61% so far (including the initial decline)

2.2 years so far

Peak not established yet

So far, we enjoyed phenomenal gains in both cases. While this data is not statistically significant, these strong results dispel the myth that you should expect declines when rates go up. So far, all [2] cases go against this theory.

Logically: The Fed acts in reaction to US and non-US economic activity. It lowered rates as a result of poor economic performance, in an attempt to stimulate the economies. Very low rates tend to be a result of big financial shocks, as we have seen in 2000-2002 and 2008. After these big shocks, the Fed was slow to reverse course and raise rates, because the risk of deflation seemed greater than the risk of inflation. By the time it raised rates, there were clear signs of economic improvement around the world. Additional rate increases were done cautiously after the economies continued to improve. The positive effect of economic improvements was greater than the negative effect of rising rates, by design. In addition, with such low starting rates, it took a long while for rates to stop being accommodative to the economy.

More Good News: While stocks did well as rates went up from low levels, you may expect stocks to get hurt when rates reach higher levels. In the history we have since 1998, the 1-year return leading to high peaks, when interest rates reached a cycle-high, was not only positive, but unusually high: The 1-year return was 92% leading to the 2000 peak, and 73% leading to the 2007 peak.

Quiz Answer:

In the past 20 years, how did Extended-Term Component perform in a period of rising rates from low rates?

  1. It gained more often than declined.
  2. It declined more often than gained.
  3. It gained consistently in all cases. [The Correct Answer]
  4. It declined consistently in all cases.
  5. As with most things, the results were mixed.

Explanation: Please read this month’s article for an explanation. Note that while the results were consistent, there were only two instances in total over 20 years, so these results are not statistically significant. A conclusion that is safe to make: we cannot count on high odds of declines as rates go up, because the history so far goes strongly against this theory.

Disclosures Including Backtested Performance Data

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Gil Hanoch

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