Don't Assume Anything From Ultra-Low Interest Rates

by: Adam Aloisi

After reading two recent articles by SA authors James Kostohyrz and Skyler Greene that take divergent viewpoints on the relationship between ultra-low bond rates, current equity valuations and expected near-term price action, I decided to take a look at the issue myself.

As a beginning, I thought it might be instructive to take a historical look at the Fed Funds rate and compare it to equity prices (Dow Jones Industrial Average) over the past four decades. Take a look at the two charts below. Do you notice anything similar about them? Would you extrapolate anything from them?

One of the things I think we can extrapolate from the graphs was that the gradually lower interest rate environment from the early/mid 80s to present day seemed to coincide with an era of broadly higher stock prices. One could thus hypothesize that lower rates therefore helped usher in the rampant bull run from the early 80s to 2000. That period had its share of ups and downs of course, most notably October 19, 1987 when the market plunged nearly 23%, and the span between 1995 to early 2000 when the DJIA made roughly a three fold move. Since the growth stock bubble burst, however, equities have cumulatively flatlined, while rates continued to drop, now to historical lows.

Few, however, remember that the gigantic five year move starting in 1995 was actually preceded in 1994 by a 300 basis point rate move higher. However, during that particular bull run, rates remained fairly flat, the only deviation being in 1998 when the Fed aggressively lowered rates to fight the "Asian contagion," which posed a threat to the global economy. By mid-1999 however, the Asian situation had moderated, and monetary policy quickly changed gears to battle an overheated economy and the proverbial Greenspan asset bubble. Post haste the bubble burst, and the broad market has basically back and filled ever since.

Another noticeable blip on the two charts was the hyper-upwards move in interest rates during the inflationary late 70s. However, the Dow was basically range bound 600-800 from 1976 through 1982, so despite the dramatic move in rates, there was no such drastic move in stocks.

Getting to the Point

Having said all this, it seems impossible to draw any definitive conclusion on the historical relationship between current or future stock prices and interest/bond rate movement. While I'm generally not inclined to make investment deductions based solely on historical data, I think it's pretty obvious, at least for the last 42 years, that there's little interrelation and some contradiction in the actions of stocks and interest rates/bonds. Thus, to provide a thesis that poses that either stocks are cheap or expensive based on a point-in-time analysis of rates is, at minimum, questionable.

Still, Kostohyrz's and Greene's respective analyses don't focus solely on rates, and each provide fundamental arguments in support of their thesis. Meanwhile, I posited my own argument on the forward market outlook here on SA last month, which states that the past decade is likely to become the next decade as far as stocks are concerned.

A summary of that article is that I think stocks, by and large, are fairly valued and that rates will remain low, the market will see rocky yet flatline-forward performance, and that skilled traders and stock pickers, focused on economic fundamentals, valuation, and market momentum, will be rewarded in the years ahead. Passive indexing and buy-it-and-forget-it equity investing, which had its day in the sun in the 90s, will by and large continue to be an unsuccessful strategy.

Further, I note that data points and fundamentals from a global macroeconomic perspective seem weak, yet domestic corporate balance sheets seem somewhat strong on the surface, a somewhat difficult disparity for investors to reconcile. To me, it calls for a market neutral stance, with implementation of various strategies to provide portfolio equity outperformance and/or diversified risk-adjusted return. Above all else, it calls for a cautious, uncavalier positioning amongst asset classes.

Near-term Strategy

For longer-term equity or dividend investors who desire exposure to the market, focus on companies with balance sheet quality, revenue underexposure to the eurozone, and low dividend payouts that can weather the foggy economy and provide stable returns. I believe that Intel (NASDAQ:INTC), one that Skyler pointed out as well, is an example of such a company. We disagree on Procter & Gamble (NYSE:PG), however, as I consider it a stock to be avoided.

I also think the sell-off in Apple (NASDAQ:AAPL) provides a point on which to nibble and I have a liking for debt-free business consulting firm Accenture (NYSE:ACN), as well as smaller cap 4% yielder B&G Foods (NYSE:BGS).

Also, for diversified players, I don't think that bonds are the risky asset class that they are commonly advertised to be. Rates are low, but since I think they will stay low, I believe short to intermediate term BBB/BB paper provides an attractive alternative to simply sitting in cash. For bolder income players, an mREIT like Annaly (NYSE:NLY) or American Capital Agency (NASDAQ:AGNC) is probably an attractive kicker, but I wouldn't recommend loading up on them.

For more sophisticated players, option strategies to either generate income or hedge current positions seem prudent. For more aggressive, assertive players, leveraged ETFs that take advantage of overbought/oversold conditions either market-wide or sector-specific should be utilized.


Similar to the high interest rates of the late 1970s, I suspect market historians will be able to look back and engross readers with the play out of the low interest rate situation we find ourselves embroiled in. The uncharted waters monetary policymakers face, coupled with other fundamental factors make this a challenging time for investors and a hotbed for polarized opinion. While pundits point to low rates as a reason to think stocks are cheap or expensive near-term, I think low rates mean very little at this juncture, and are just another data point investors might take into account when plotting strategy. If the market were to make a giant move up or down from here, which I consider unlikely, it won't be looked back upon because rates were low.

Disclosure: I am long INTC, ACN.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.