stocks vs. bonds when interest rates are rising (ii)

yesterday’s post: bonds

To summarize yesterday’s post, when interest rates are rising, newly-issued bonds bear higher coupons than ones issued in the recent past. Older bonds look less attractive, because they provide less return.  So they have to go down in price until they’re trading at equivalent returns to new ones.

Other than inflation-indexed bonds, Treasuries have no defense against this.

What about stocks?

Here the issue is a bit more complicated.

Let’s make the useful, and more or less correct, assumption that stocks and bonds are in equilibrium before rates start to rise.  If so, if bonds get cheaper, stocks will also have to get cheaper in order to compete for investor money against now-higher-yielding bonds.

This means rising rates puts downward pressure on stocks, too.

But stocks do have a defense.  It has to do with why rates are rising.

In most cases, rates begin to rise when either bond investors or the Fed sense incipient inflation that threatens to erode the purchasing power of money.  This is what triggers the impulse to raise rates.  Since in advanced economies, inflation is always an issue of wage inflation, its early warning signs are that the economy is reaching full employment and/or wages are beginning to rise at an accelerating rate.  In the US, that’s where we are now.

But more workers employed and wages rising at a healthy clip imply that consumer spending is likely to rise at an accelerating rate.  This implies accelerating profit growth for, in sequence, retailers, their suppliers and the providers of capital goods to both retailers and suppliers.  To the extent that a given stock market represents the local economy (which about half of the S&P 500 does), profits of publicly traded companies will start to go up at an unexpectedly sharp rate.

Rising profits create upward pressure on stock prices that serves as at least a partial counter to the downward pressure created by rising rates.


A second issue that will affect stocks directly is how the combination of inflation and higher rates affects the local currency.

If the currency falls, which is the most common case, export-oriented or import-competing companies will have the best results.  Purely domestic firms, and domestic firms that use foreign inputs, will fare relatively poorly.

If the currency rises, the opposite will most likely happen.

the S&P 500 in past times of rising rates

In the US in the past, the upward pressure from rising profits and the downward pressure from rising interest rates have most often neutralized each other.  There have certainly been diverse sector and industry performances, based on currency, technology, government fiscal policy and the overall state of the world economy.  So there have typically been substantial outperformance opportunities even in a sideways market.  But the overall market tendency in the early year or so of rising rates has typically been sideways, not down.


Tomorrow, REITs.



Veterans Day …and my birthday!

Given that way back when I served in the 101st Airborne, it’s a double holiday for me.

…a post nevertheless.


Yesterday was Day 2 of the President-to-be Trump era.

S&P 500 gains were more modest than on Day 1, but the general pattern of trading was similar.  Action continued to be “conceptual” in nature, that is, industries that Wall Street thinks will benefit from an end to Congressional gridlock generally did wellIndustrials and Basic Materials, for example.  Both parties have long favored amped-up infrastructure spending, but Republicans had previously blocked any initiatives.  We won’t know what Democrats would do were positions reversed, but with Republicans in control of both houses any attempt to ape their past anti-Obama behavior will prove ineffective.

Financials continued to outperform strongly, both on the idea that finally getting fiscal stimulus will free the Fed to alter its super-low interest rate stance.  The market also seems to believe that some restrictive provisions of Dodd-Frank will be removed come 2017.  Whether this is good or bad remains to be seen (for what it’s worth, seeing that no one has gone to jail and the same clowns who caused the financial crisis are still in charge, my vote is “bad”).  If some shackles come off, however, bank profits for a while will be higher than previously thought.  (Note:  despite my just-expressed distain, I own JPMorgan Chase.  I guess I’m a Wall Streeter at heart.)

Healthcare was up as well, on the idea that the industry will have greater pricing power under Republicans.  Healthcare firms also generally pay corporate tax at the highest rates–the reason inversions have been so prominent in this sector.  Tax reform would presumably benefit these companies more than others.

Yesterday also saw sharp losers.  Telecom, Utilities and Staples were all down by over -2%.  IT came close to that mark, at -1.8%.  IT seemed to me to suffer from serious derivative-led selling.  Don’t ask me why.  The only sense I can see in the rest is that the US$ has begun to rise, potentially lowering the profits from Staples.  The idea that rates will be rising for sure, and faster than under a Hillary administration, is behind the weakness in bonds, Utilities and possibly Telecom as well.

Energy took the day off.


A closing thought:  if we were to roll back the clock by a week, liberals could have imagined that when Hillary won, disgruntled Trump supporters might organize anti-Clinton demonstrations in right-wing hotbeds.  These protests would have been labelled as typically Trumpish, and disgraceful.

As regular readers will know, I’m not a fan of Trump.  It seems to me, however, that the most effective way to influence Mr. Trump is to boycott the products bear his family name, not to cast doubt on peaceful transition of power to the election winner.