A Rising Interest Rate Environment – Friend or Foe of the Stock Market

Written by: Martin X. Shields

Given the recent strength in the labor markets and the continuation of slow but steady growth in the economy, the question pertaining to the Federal Reserve Bank for 2015 is whether they will begin raising interest rates. The general consensus is that unless something dramatic changes, they will most likely begin raising rates in the second half of next year. The concern of stock investors is that with the Fed beginning to raise interest rates, this stimulus that has been in place since the start of the bull market will be removed and it will have a negative impact on the markets.

 
Whether it be raising interest rates or eliminating its bond buying program (a.k.a quantitative easing) our perspective has been that these are signs the economy is strong and is a positive for the markets. As a firm we believe that history doesn’t repeat itself but it does rhyme, so looking at historical data can provide us with a good perspective of what to expect at this point in the business cycle.

 
The chart below shows the correlation between the weekly performance of the stock market and weekly increases in the 10 year US Treasury yield. As is shown below, when the 10 Yr. Treasury rate is below 5% and is increasing, there is a positive correlation to the performance of the markets. This correlation does not become negative until interest rates are above 5%. With the 10 yr. US Treasury rate at 2.25%, we would suggest that we have a long way before rising interest rates will have a negative impact on the performance of the markets.