Can Interest Rates Predict Stock Market Performance?

Much talk has been made recently about rising interest rates.  One of the most followed gauges of interest rates is the rate paid when the US government borrows money.  This information is regularly available and acts as a proxy for interest rates in the economy.  The government routinely borrows money at differing time intervals, e.g., 2 years, 5 years, 10 years, 30 years, etc.

Depending on the marketplace, each time interval likely has a different interest rate.  Interesting, these interest rates have historically been a signal to stock investors as well as bond investors.  Allow me to clarify:

As of 4/26/18, the 2-year Treasury Bond interest rate was 2.48%

As of 4/26/18, the 10-year Treasury Bond interest rate was 2.95%.

Therefore, the government is paying an extra 0.47% to borrow money for 10 years rather than for 2 years.

Three years ago, the difference between those two yields was 1.50%.

So what?

Well… the difference in bond yields may act as a pretty solid indicator of future returns in the stock market.  If there is only a small difference between the two (less than 1%) it generally implies we are in the later stage of the economic cycle, and future stock market returns may be muted.  Take a look at the following numbers for the S&P 500 since June, 1976, (the earliest data set I could readily find). 

 
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Ideally, investors like to see steeply sloping yield curves with a big difference between short term and longer term rates.  The implications of interest rates today suggest once again that the upward trend in the stock market over the last 10 years may be running out of steam.  Returns may be muted over the coming year, and the odds of a negative outcome may increase.  Investors may be wise to look for returns in more defensive areas of the investment world and scale back on their stock exposure.

Any opinions are those of Brady Raanes with Raanes Capital Advisors, LLC and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice.  The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected.

The S&P 500 is an unmanaged index of 500 widely held stocks that's generally considered representative of the U.S. stock market.  Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results. All investing involves risk and you may incur a profit or a loss. There is no assurance that any investment strategy will be successful. The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision,
and it does not constitute a recommendation. Any opinions are those of Brady Raanes and not necessarily those of Raymond James.

The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results.