Much Ado About Interest Rates
NEW YORK ( MainStreet) The prices of equities are not always driven by interest rates, several experts said.
While it appears that an increase in interest rates would drive down stock prices, that scenario is not always true, said Craig Lazzara, global head of index investment strategy for S&P Dow Jones Indice, in a recent research blog post.
The past 15 years of returns for equities indicate the opposite, he said. Since 1998 when the 10-year Treasury rates declined, the average return on the S&P 500 was -0.38%, Lazzara wrote in the report. However, when the 10-year Treasury rose, the S&P 500 rose by an average of 1.81%, the report said.
"This counterintuitive behavior suggests that interest rates were not driving stock prices, but rather that both rates and stock values were both being driving by exogenous factors," Lazzara said.
The Federal Open Market Committee chose to continue to purchase bonds at $85 billion each month in a meeting last week. This move surprised the financial markets, which had counted on a small adjustment to the past five years of a lax monetary policy. The FOMC could chose to limit the number of bonds it buys back in late October. Tapering the Fed's quantitative easing program would result in interest rates rising.
Rising interest rates do not always affect stocks negatively, said Fei Mei Chan, associate director of index investment strategy for S&P Dow Jones Indice.
"It is not a sure thing that interest rates are bad for equities," she said. "It does have an impact on equity performance. We're sitting at a historical low in interest rates. It's not a matter of if interest rates will rise, but when they will increase. Everyone is anticipating the increase."
Between January 1991 and June 2013, the average monthly return for the S&P 500 was 0.85%, according to a report by Chan and Lazzara.
"Paradoxically, in the three periods of rising rates, the average monthly return was 0.96%, compared to an average monthly return of 0.82% for the periods of declining rates," the report said. "Rising rates have clearly not been bad for stocks over the past two decades."
Even the possibility of tapering can result in interest rates rising, Chan said.
"The market has been bipolar," she said. "Keep in mind that aside from interest rates, many things go into equity performance."
When interest rates are low, investors focus more on equity performance instead of bond returns, said Aaron Izenstark, managing director of IRON Financial, based in Northbrook, Ill.
"It's a scale," he said. "Investors are going to weigh what they can get potentially."