Higher Move in Interest Rates Not Necessarily Bad for Market

by: William Fairbanks

The stock market, as we all know, has made one of its quickest and largest recoveries ever in history, over the past year. This move has been aided in great part by an abundance of cheap money. Since the Fed and the Treasury have turned on the spigots, standing in front of this uptrend in hopes of a reversal back to newer and lower lows has been an exercise in futility.

As we close in on the important 62% Fib level on the S&P, as well as several key resistance areas on the DJI, we are starting to see signs that the market has become over bought in the near term from a technical perspective. After a brief respite from its climb in January, the market has resumed its recovery with a vengeance, now having gone nearly 30 days without even a 1% pullback, much less a more serious correction. And it has done this with declining volume throughout the entire move up for the past year. So caution has become the new watchword as traders and investors wait for the so-far, never coming pullback.

The end result is you have three groups of participants in the game now: those who bought into the move in the early phase and are extremely happy, those who have missed a large part of the move up are but are now eagerly awaiting a pullback so that they can get into the game and third, those who think the whole move up is simply a correction in a major new downtrend and can’t wait to pounce once selling begins, hopefully soon, since some are probably already underwater on short positions. Of these three groups, 2 of the 3 are eagerly looking for topping signs or, if not finding many lately, reasons why it should be topping soon.

One of the more prevalent reasons I’ve heard lately, besides certain overbought indicators, has been the recent climb in interest rates to a small degree and the expected greater increase as governments all over the world, but especially ours, have a lot of refinancing to do, as well as plenty of new, in our case. So the pervasive argument is that as rates move higher, this will make stocks less attractive. There is no doubt that we could be close to breaking a 20-30 year general down trend in interest rates, but I think a look at the charts below may surprise you.

US Treasury 20 Year

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As you can see in the chart above I’ve highlighted the areas where the 20 year rates were moving up. You can also see the SPX in the top of the chart and its performance while rates were moving up. I can see no correlation in the past 20 years that rising rates had a negative effect on the market. Now obviously at some point, if we reached rates like in the late 70s and early 80s with rates above 10%, then it may become a different story.

Below we have similar results looking at yields on the 10yr notes.

US Treasury 10 year

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The net result that is that those thinking a move up in rates will be the trigger for a pullback they’ve been looking for may be disappointed. We may certainly get a correction soon, but I don’t believe it will be because of interest rates. Now there are always those that may argue that traditionally when rates move up it’s because the economy is growing. Therefore it’s normal that the market moves up then also, but that this time it’s for a different reason that rates are moving up, more supply than demand. I think we’ll know soon enough.

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