How Rising Rates Affect Stocks
By Cliff Aque, CFA, Investment Strategist
At the most basic level, investors diversify their investment portfolio between stocks and bonds. This diversification works because the returns of stocks and bonds tend to be uncorrelated, and bonds act as a ballast against stock market volatility. February 2018 showed that there can be times when they both move lower, as concerns over rising inflation drove interest rates higher (bonds lower) and stocks lower.
Rising rates are not always bad for stock prices as they normally accompany periods of stronger economic growth. This is currently happening, with global growth accelerating and a strong fiscal stimulus package announced in the U.S. With this solid fundamental backdrop, stocks appear poised to continue to do well. Additionally, in times such as those we have experienced in Q1-2018 when rates rise from a low level, there have been many periods of positive stock market returns. Over the last 20 years, the S&P 500 was up 24 out of 28 months when interest rates rose more than 25 basis points.
Investors should continue to diversify their investments, but adjust their return expectations as the markets enter the next phase of the economic cycle. The “lower for longer” era is over and we are likely to see it replaced by higher growth, higher inflation, higher interest rates, and higher volatility.