One of the oldest rules on Wall Street is, don’t fight the Fed. When the Federal Reserve is cutting rates, you want to be long equities, and when it is tightening, get out of the way. This has been a cause for concern since the Fed began talking of tapering its program of quantitative easing and ending its zero interest-rate policy.

But the knee-jerk response to an over-simplified rule of thumb might be wrong. When we look at the actual data — what happens to stocks when rates rise — we find a very different set of results than this heuristic suggests. Before I get to the numbers let’s look at both the positive and negative sides of increasing rates.

It is understandable that there is concern with a rising-rate environment. Often, higher rates signal an overheating economy, higher costs of credit to purchase goods and services and a potential profit squeeze as operating expenses rise. When the Fed is in its inflation-fighting mode, too much tightening will cause a recession.

However, there are also positives to increasing interest rates. Rates are merely the price of capital. Higher demand for capital means the economy is strengthening, as consumers borrow to spend on goods and to buy homes and companies seek to hire and do more investment spending. Higher rates also mean the risk of deflation is decreasing. Lastly, it reflects a normalization of Fed interventions, which today would suggest that the credit crisis is behind us.

Continues here

 

 

 

Category: Federal Reserve, Fixed Income/Interest Rates, Investing, Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Rising Rates Unliklely to Kill This Bull Market”

  1. Concerned Neighbour says:

    I disagree. Low rates have allowed companies to borrow to buy back shares, which has a been a large contributor to growth in earnings per share. Also low debt service costs have contributed to some of the highest profit margins in history. As interest rates increase and/or the economy picks of up steam, profit margins will come down and already highly leveraged corporate balance sheets will inhibit further borrowing to buy back stock. Also using a non-zero discount rate can’t help but let the air out of all the capital mis-allocation encouraged by monetary policy the last five years. I’m highly doubtful that a stronger economy, should one actually materialize, can ramp up revenue growth enough to offset these other factors.

    That said, a higher S&P 500 is obviously a prime policy tool of newfangled monetary policy, so they can always just push valuations even further with their not-so-invisible hands.

    • rd says:

      Historically the Fed Funds rate was fairly close to the inflation rate but that has not been the case for several years now. Presumably, the Fed Funds rate could rise a point or two to the level of the CPI without significant internal impact. However, it is not clear what that would do to the US dollar – a rise in that could impact exports.

  2. itsgold says:

    Rising rates might also attract more foreign investment.

  3. RW says:

    Current economic growth rates are too slow to imply a significant increase in interest rates.

    Central banks tend to be reluctant and insufficiently proactive when easing is required and generally very eager to pull back or even tighten at the slightest bump so, assuming Yellen can’t keep the hawks in line, further pull back seems likely and, eo ipso, economic growth is likely to slow even further.

    A continuing increase in equity prices is not unlikely but there isn’t much reason to think its going to continue at anything like the pace of the past few years. OTOH, any bet on falling long bond prices, dollar depreciation, etc is likely to be unprofitable. Most indications are we will continue to just “muddle through” but I certainly would appreciate a decent pullback in equity prices; I’m just not seeing many decent entry points at the moment.

  4. spencer says:

    The S&P 500 divisor fell -0.39% in 2011, -1.31% in 2012 and -0.12% in 2013.

    That is how much stock buyback, etc, boosted earnings per share over the last few years.

    The divisor rose in 2009 and 2010, so it reduced reported EPS in those years.

  5. ch says:

    Rates can never rise again until the global currency system is restructured. Every 100bps = $160B in added Federal interest expense. That is ~12% of personal income tax receipts. So to normalize Fed Funds to the 50-year average of 3% would require the US to begin spending 35-40% of personal income tax receipts on interest expense alone…just as the Baby Boomers’ health & retirement costs kick into high gear.

    Not going to happen until the Petrodollar system is changed (that is closer than most realize but a different discussion.) End of story.

  6. [...] recent article by Barry Ritholtz (which you can find here: http://www.ritholtz.com/blog/2014/07/rising-rates-unliklely-to-kill-this-bull-market/) covered the effect rising rates have on the stock market. Its focus was the likelihood of the [...]

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