Rising bond yields have been a major catalyst for equity withdrawals over the past year.
But with the market shifting to expect interest rates to remain higher than the previous decade for longer than many initially hoped, Brian Belsky, chief investment strategist at BMO, points out that high rates haven't always been a bad environment for stocks.
In an analysis dating back to 1990, Belsky found that the S&P 500 monthly return actually achieved its best average annual returns when the 10-year Treasury yield (^TNX) was higher.
Belsky's work shows that the benchmark achieved an average annual return of 7.7% in months when the 10-year Treasury yield was less than 4%, compared to an average annual return of 14.5% in months when the 10-year Treasury yield was years 6%.
“In a higher interest rate environment, certainly higher than 0% to 1% or 0% to 2%, stocks traditionally do very well,” Belsky said. “So I think we're resetting that, and we still believe that from these levels inventories are higher at the end of the year.”
Belsky's research shows that on average, stocks performed better in a high-ratio environment than in a low-ratio environment as well. The average one-year rolling annual return for the S&P 500 during a low interest rate environment is 6.5%, while it is 13.9% in a high interest rate regime.
He said this makes sense given that one of the reasons the Fed keeps interest rates low, or lowers them, is slowing economic growth expectations. Given the current backdrop in which the Fed feels the economy is in a strong position to handle higher borrowing costs, an interest rate increase may not be so bad for stocks, Belsky said.
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