Rising Bond Yields and Stock Drawdowns: Uncovering the Relationship
Rising bond yields have had a significant impact on the stock market in the past year. The correlation between the two has been widely acknowledged as a key catalyst for stock drawdowns and market fluctuations. However, as the market continues to shift, it appears that higher interest rates may persist for longer than initially anticipated. Interestingly, these higher rates haven’t always resulted in a negative environment for stocks, according to BMO’s chief investment strategist, Brian Belski.
The Surprising Relationship between Bond Yields and Stock Market Performance
In an insightful analysis spanning back to 1990, Belski examined the S&P 500’s monthly return in relation to the 10-Year treasury yield. Surprisingly, Belski’s research revealed that the S&P 500 actually delivered its best annualized average returns when the 10-Year treasury yield was higher.
For instance, in months where the 10-Year treasury yield was below 4%, the S&P 500 delivered an average annual return of 7.7%. However, during months when the 10-Year treasury yield reached 6%, the benchmark average soared to an average annual return of 14.5%. This data challenges the commonly held notion that higher interest rates are inherently detrimental to stock market performance.
Rethinking the Relationship: Higher Interest Rates Can Benefit Stocks
Belski’s research suggests that in a higher interest rate environment, stocks tend to perform exceptionally well, especially compared to a low-interest rate scenario. This observation holds true even when analyzing the average annual rolling 1-year return for the S&P 500 in rising and falling rate environments.
During a falling rate environment, the S&P 500 yielded an average annual rolling 1-year return of 6.5%. In contrast, in a rising rate regime, the average annual rolling 1-year return surged to 13.9%. This evidence contradicts the notion that stock market performance suffers during rising interest rates.
The Significance of a Strong Economic Outlook
One potential reason why higher rates may not be detrimental to stocks, but rather beneficial, lies within the broader economic outlook. Should the Federal Reserve choose to keep rates low or decrease them, it would suggest a pessimistic view on economic growth. However, in the current backdrop where the economy demonstrates strength and an ability to withstand higher borrowing costs, increased rates might not negatively impact stocks.
“If we can hover between this 4% and 5% range on the 10-Year Treasury yield, maintain robust employment, and most importantly, witness strong earnings and cash flow, I firmly believe that the market can flourish,” remarks Belski, offering a fresh perspective on the potential advantages of higher interest rates.
