In the past in the US when the Fed has raised interest rates from recession-emergency lows, bonds have gone down and stocks have gone sideways to up.
Will this time be an exception? …another way of saying, Will stocks go down this time around?
The generally accepted explanation of the divergence between stocks and bonds while the Fed is normalizing interest rates after a downturn is that the negative effect of higher rates is offset, in the case of stocks, by the positive effect of strong earnings growth. Bonds–other than junk bonds, or municipal bonds–don’t have this offsetting factor. So for Treasuries the news is all bad.
(There are at least two reasons why interest rates matter for stocks:
–broadly speaking, people (me being a possible exception) don’t actually want to own stocks. What they want is to own liquid long-term investments so they can fund their retirements and send their kids to college. Those can be either stocks or bonds. A decline in the price of bonds makes them more attractive, taking some of the shine off stocks.
–in broad conceptual terms, the worth of a company should be related to the value in today’s dollars of its future earnings. To the extent that investors use today’s interest rates to discount future earnings back to the present, rising rates will result in lower present values.)
I remain squarely in the “sideways to up” camp, but I can see, and am monitoring, two possible worries that may weaken the case for s-t-u:
–in what has been to date a sub-par rebound from recession, earnings growth may not be as strong as in prior recoveries, and
–the S&P 500 is a global index, about half of whose earnings come from abroad. Even if US-sourced earnings are great, the same may not be true for foreign-sourced. In particular, an increase in the value of the dollar vs. the euro caused by increasing interest rate differentials (the worry of the IMF and World Bank) could mean a lower dollar value for EU-sourced earnings (which make up about a quarter of the S&P 500 total).
More tomorrow.