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In the Market - September 2008
Sep 15, 2008
Bond Turn Around Bodes Well for Stocks
An interest rate increase could be just what the doctor ordered for the equity markets. In exploring the relationship between interest rates and equity performance, we identified 16 periods over the last decade where long term interest rates rose by more than 50 bps and ran an interest rate stress test to determine the impact to each sector of the S&P 500 of a substantial rate increase.
As noted in Chart 1 below, though the magnitude of the response is relatively small, all sectors of the S&P 500, with the exception of Utilities, show a positive correlation to higher interest rates. The sectors with the biggest responses are the most economically sensitive: Consumer Discretionary, Information Technology and Materials. On the other end of the spectrum, Utilities, drop in the higher rate environment, logically, behaving more like bonds.
The second chart shows the same stress test run using data over the last year and it differs significantly in magnitude and sector sensitivity. The S&P relationship to interest rates is 6 times stronger over the last year than it has been historically and the biggest sensitivity to interest rate is in the Financials. There are two potential explanations for this, beyond the current high levels of volatility. One, the higher interest rate environment is not driving stocks, but the economy is a driver of both stocks and bonds. And two, the measure of health of the US markets has shifted from Cons Disc, IT and Materials to Financials as the bellwether.
Chart 1
* Stress test on a portfolio of the S&P 500. Stressing the 30 year bond +100 bps over a time periods when the 30 year bond rose 50 bps without a 25 bps retraction. The list of these periods is shown to the right. |
Chart 2
** Stress test on a portfolio of the S&P 500. The 30 year bond was stressed +100 bps over the last year with no decay factor. |