Rising bond yields have been a key catalyst for stock drawdowns over the past year.
But as the market shifts to expect that interest rates may remain higher than the previous decade for longer than many initially hoped, BMO chief investment strategist Brian Belski notes that higher rates haven’t always been a bad enviornment for stocks.
In an analysis spanning back to 1990, Belski found the the S&P 500’s monthly return has actually delivered its best annualized average returns when the 10-Year treasury yield (^TNX) was higher.
Belski’s work shows the benchmark average delivered an average annual return of 7.7% in months where the 10-year Treasury yield was less than 4%, compared to an average annual return of 14.5% in months when the 10-year was 6%.
“In a higher interest rate environment, certainly higher than 0% to 1% or 0% to 2%, stocks traditionally do very well,” Belski said. “So I think we’re recalibrating that, we still think from these levels stocks are higher at year end.”
Belski’s research shows that on average, stocks have performed better in a rising rate enviornment than in a falling rate environment, too. The average annual rolling 1-year return for the S&P 500 during a falling rate enviornment is 6.5%, while it’s 13.9% in a rising rate regime.
He argued this makes sense given that one reason the Fed would keep rates lower, or cut them, would be a sluggish economic growth outlook. Given the current backdrop is one where the Fed feels the economy is in a strong position to handle higher borrowing costs, increased rates might not be so bad for stocks, Belski said.
“If we can hover between this 4% and 5% range [on the 10-Year Treasury yieldand still have strong employment, but most importantly, have very strong earnings, and oh by the way cash flow, I think the market can do very well,” he added.