The 10-year Treasury yield is settling in at a higher level than it was a few short weeks ago. The size of the move since July 2020—and the more recent acceleration—has some market participants worried about the potential impact on stock markets, particularly if rates continue to rise. Historically, the S&P 500 Index has endured extended periods of rising rates. If an improving growth outlook is part of what is driving rates higher, it should also support corporate profits, creating a positive fundamental backdrop for stocks.
In looking at major extended periods of rising rates dating back to the early 1960s, there are 13 periods in which the 10-year Treasury rose by at least 1.5%, much higher than this recent move. These rising-rate periods lasted between six months and almost five years, with the average of a little over two years. In nearly 80% (10 of 13) of the prior periods, the S&P 500 Index posted gains as rates increased, as it has so far in the current period. The average yearly gain for the index during the previous rising-rate periods, at 6.4%, is just a little lower than the historical average over the entire period of 7.1%. Not all rising-rate periods are the same, though, and hopefully stocks tolerate the current rising-rate period.
How markets have performed during a rising-rate period has depended heavily on what is going on in the economy, with inflation a leading consideration. Rising rates during periods of high inflation have generally resulted in lower stock returns, although the level at which inflation has become a headwind is well above what anyone expects now.
From 1968 to 1990, the Consumer Price Index (CPI) rose an average of 6.2% per year and was above 3.5% every year except three. Five of the rising rate periods took place at least partially during those inflationary years. The average annual return during those rising-rate periods was -0.4%. During all other rising-rate periods, the average annual return was 13.0%, well above the average for all returns since 1962. While inflation expectations are rising right now, CPI growth of 2.5% at the end of the year would be a surprise based on the median estimate of Bloomberg-surveyed economists. For all the concerns about inflation, we are a long way from the ‘70s and ‘80s.
During the four rising-rate periods that saw the least yield curve steepening, as measured by the difference between the 3-month Treasury bill and the10-year Treasury note, S&P 500 Index returns were weaker than for a typical period, averaging an annualized 3.5%. In the four periods when the yield curve steepened the most, the S&P 500 averaged an annualized 14.5%.
While yield curve steepening has not yet been dramatic enough to make its way into the top four periods historically, we have seen considerable steepening already. With the Fed likely on hold for some time, anchoring the short end of the curve, we expect that if rates continue to rise, it will come with further steepening. Some of that may be because of rising inflation expectations, but the main driver is likely to be an improved growth outlook. It could also be a due to a technicality – current uncertainty about how bank reserves are counted if Treasuries are not excluded from bank leverage restrictions. Banks have been selling their Treasury holdings possibly due to this uncertainty.
Rates have been rising but they are still historically low, with the 10-year Treasury yield at the end of February falling into the bottom 2% of all values dating back to 1962. While it is true that rates become a bigger burden for business, consumers, and governments as they rise, even at current and higher levels, rates are still attractive and can continue to support a robust economic rebound.
Looking back again at the different rising rate periods, during the four periods with the highest initial 10-year Treasury yield, the S&P 500 averaged a 2.5% annualized return, while those with the four lowest initial yields averaged 15.4%. A lower initial yield likely reflects manageable inflation and a Fed that is not tightening, but it also represents the added economic support of a still low cost of borrowing even as rates rise.
Rising interest rates have clearly been one of the reasons the S&P 500 has consolidated since hitting its last all-time high on February 12, particularly affecting the high growth sectors. Rising rates in general have not prevented stocks from advancing, and the current environment improves the odds that stocks will be able to continue to press higher. Rising rates are being driven in part by an improving growth outlook. Inflation, while normalizing, is still well below levels that have historically disrupted markets. The Fed remains supportive, and borrowing costs are still historically low.
Every market environment is unique, but taking our cues from history, the economic fundamentals continue to look strong, and the current rising rate picture looks most like those periods of above-average stock performance.
The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by LPL Financial and Bloomberg.
- Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.