What Rising Rates Really Mean for Stocks

07/05/2013 8:00 am EST

Focus: MARKETS

Mark Salzinger

Editor and Publisher, The No-Load Fund Investor

Should rising interest rates scare you out of the market? History suggests that would be a mistake, according to Mark Salzinger of The No-Load Fund Investor.

In case intermediate- and long-term rates have started a strong upward trend, it makes sense to review what has happened to stocks and bonds during past periods when rates rose significantly.

For the purposes of our review, we went back several decades and decided that increases in the yield of the ten-year Treasury by about two percentage points or more over a 12-month period were "significant," and then examined how various equity and bond indexes performed during these periods.

For example, in the 12-month period ended May 31, 1981, the yield of the ten-year Treasury rose by 4.32 percentage points to 14.1%. During this same period, the Barclays Long-Term Treasury Index had a total return of negative 6.9%, even while earning a double-digit rate of income.

However, equities were not harmed by the increase in rates. The S&P 500 and Russell 2000 (small US stocks) produced huge gains: 25.2% and 58.6%, respectively.

From January 1980 through September 1981, the yield of the ten-year Treasury rose to 15.32% from 10.8%, and then began a gradual decline. During this 21-month period of rising rates, the Barclays Long-Term Treasury Index produced a loss of 14.3%, while a similar index for municipal bonds lost even more: 17.1%.

However, as measured by the Barclays Aggregate Bond Index, the intermediate-term area of the investment-grade US bond market lost only 1.3% during this time, while the S&P 500 and Russell 2000 gained 17.8% and 28.4%.

Somewhat more recently, however, the data are not so good for stocks when rates rise. In 1987, for example, the yield of the ten-year Treasury rose by about 1.9 percentage points, to 9%. Stocks crashed in October, and finished the year up only 5.2% in the case of the S&P 500 and down 8.8% in the case of the Russell 2000. The long-term Treasury index was down about 2.7%, but a similar index for intermediate-term Treasuries was still up 3.6%.

In 1994, when the yield of the ten-year Treasury rose by nearly 2.1 percentage points, long-term government, corporate, and municipal bonds lost between 5% and 10%, as did intermediate-term bonds.

Stocks, meanwhile, produced either very small losses or very small gains that year. The S&P 500 produced a total return of 1.3%, while the Russell 2000 was up 3.1%. The growth segment of the Russell 2000, however, lost 2.4% that year.

Looking back more than four decades, there is no evidence that the simple incidence of ten-year rates rising or falling has had a significant impact on the performance of the US equity market. Since 1972, the S&P 500 and Russell 2000 have produced gains on average of 11.9% and 18.3%, respectively, when rates increased during the year, and 11.3% and 11.8% when rates decreased.

So when it comes to equities, we wouldn't worry so much about rising rates, except that one might want to shy away from too much exposure to small-cap growth stocks during such times. It also wouldn't be unreasonable to use some of the money you'd ordinarily devote to bond funds to large-cap US stock funds.

Despite conventional wisdom, the data show that while volatility in the equity market might increase with higher interest rates, total returns over extended periods of higher rates wouldn't necessarily go negative.

Subscribe to No-Load Fund Investor here...

More from MoneyShow.com:

Trading on Fed News

An Option Play on Higher Interest Rates

What Are the Chances of a Recession?

Related Articles on MARKETS

Keyword Image
11 Reasons to Buy Microsoft
9 hours ago

For our latest recommendation, we revisit one of the world's most prominent technology companies, Mi...

Keyword Image
A Trio of Top-Tier Biotechs
9 hours ago

We hold three biotech stocks in our growth portfolio — Biogen (BIIB), Bioverativ (BIVV), and R...