Why Higher Interest Rates Are A Good Thing For Stocks

Will they or won’t they? The Federal Reserve has their decision on interest rates this afternoon and there is no way they raise rates today, but the consensus is they might do it at the September meeting. I remember last month, 12 big banks came out and all said September would be the next Fed rate hike. Well, here is a more recent CNBC article that says the majority still expect a hike in September and 82% think we’ll see a hike sometime this year. I’ve been in the stance all year we won’t see a hike this year and I still feel that way. Maybe I just like being a contrarian, but I’ve been hearing for over a year about how higher interest rates are coming and I haven’t seen it yet. Just don’t think it’ll happen till next year and potentially not till after the election in well over a year.

There seems to be a good deal of worry over how the first rate hike will send stocks crashing down. Again, I’m in a different camp – I think higher interest rates will lead to higher equity prices. The reality is higher rates tend to happen in times of strong economic growth. This is what we’ve seen during the three major rate increases the past 20 years. You could say we had high rates in the early ’80s to fight off inflation, well, we aren’t seeing any inflation today, so I don’t think that is why rates will increase.

The economy is doing ok, is my quick summary. Still, with QE over you have to say things are doing better than most would have expected. So many said the world would end and the stock market would crash once QE3 ended. Well, the economy is showing signs of life and the market has traded in a boring range the past eight months. But after being up for six years, some boring action isn’t a reason to panic.

So, if/when we do see higher interest rates, how will stocks handle the news? Let’s look at what happened after the last time the Federal Reserve increased rates (Fed funds rate vs S&P 500).

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higher interest rates versus stock market 2004-2007 chart

Then in the late ‘90s ahead of the Y2K worry.

higher interest rates versus stock market 1998-2000 chart

Lastly, in the mid-90s higher interest rates did little to slow down equity prices.

federal reserve rising interest rates versus stock market 1994-1995

Maybe higher rates aren’t this bear market signal like so many are telling you. When should you really worry? To me, it looks like lower rates are when things start to unravel.

federal reserve cut interest rates 2008-2009 chart

federal reserve cut interest rates stock market 2000-2003 chart

Trust me, it is never this simple and there are always other factors. I’ve tweeted these charts the past week or so and always get a lot of feedback. I like that, as it means these charts make people think. You guys know me though, I like to keep things simple. Going back 20 years, higher interest rates aren’t anything to get worked up over. They are not a reason to be bearish by itself.

Now what does worry me? First up, the Dow Jones Industrial Average is up six straight years. Since 1900, it made it to seven just once and that was during the amazing run during the ‘90s. That fun ended with the first three year losing streak in a generation.

dow jones industrial average up year down year 1900-2014 chart

We’ve heard non-stop about how bad breadth has been. Although I tend to side with the argument that the weakness is coming from sectors that don’t have big weightings in the S&P 500 (like materials and energy), whereas, the big boys like tech, financials, and consumer discretionary are holding tough. As long as the big sectors hold up, don’t get overly worried yet. Here’s a chart I made last night to show this one.

s&p 500 market value by sector july 2015

Lastly, here’s a chart that shows the advance/decline line for common stocks only on the NYSE. In other words, this removes closed-bond funds which can skew things. Well, this just broke to its lowest level this year. Given the S&P 500 hasn’t broken down yet, this could say there is trouble lurking under the surface.

nyse advance decline line chart july 29 2015

Thanks for reading and good luck out there.


Twitter: @RyanDetrick

Any opinions expressed herein are solely those of the author, and do not in any way represent the views or opinions of any other person or entity.