Wednesday, March 23, 2005

Do Higher Interest Rates Lead to Lower Stock Prices?

A couple of posts ago I looked at the impact of inflation on the stock market and concluded that the correlation really is very weak, i.e., higher inflation does not "normally" lead to lower (nor higher) stock prices. Today I take a look at interest rates, in an effort to find some historical evidence to support the general market sentiment that higher interest rates "cause" lower stock prices.

Common economic "theory" says that, as interest rates rise, stock prices should fall, since investors will demand a higher return on investment (i.e., investors will now pay less for a given future earnings stream) in a higher interest rate environment. Offhand, this logic seems plausible. As interest rates rise, bond prices fall--and so should stock prices, since stocks are a "substitute" investment for bonds.

To see if history supports these common investor beliefs, I took a look at interest rate (10-year Treasury) and stock price (S&P 500) data for the past two centuries:

(Source: www.globalfindata.com)

Period: 1801 to 2004
Average annual % change in 10-yr. Treas. rate: 0.3%
Average annual % change in S&P 500: 4.4%
Correlation between inflation and stocks: -0.14

Quartiles: I, II, III, IV (sorted by change in Treas. rate, from high to low)
Average annual % change in 10-yr. Treas. rate: 13.5%, 1.8%, -1.8%, -12.2%
Average annual % change in S&P 500: 3.9%, -1.6%, 4.8%, 10.6%
Correlation between inflation and stocks: 0.03, -0.10, -0.30, -0.02

Note: "% change" is defined as (R2-R1)/R1, where R1 and R2 are rates or prices in consecutive years.

For this 204-year period, the correlation between interest rates and stock prices has generally been weak, based on annual data. Rising interest rates have been accompanied by falling stock prices just as often as they have by rising stock prices. Quartile data also do not show any pronounced pattern with a strong enough correlation coefficient to lend support to a cause-effect relationship.

Nor is there any obvious pattern among the years with the largest percentage changes in interest rates:

Year: % Change in 10-Yr. Treas. Rate, S&P 500 Return

1999: 38.7%, 19.5%
1994: 34.5%, -1.5%
1919: 30.7%, 14.0%
1969: 27.9%, -11.4%
1967: 22.8%, 20.1%
1987: 22.1%, 2.0%
1931: 22.1%, -47.0%
1959: 21.5%, 8.5%
1956: 21.3%, 2.6%
1814: 21.3%, -16.7%
1950: 21.1%, 21.8%
1980: 20.3%, 25.8%
1958: 20.3%, 38.1%

For example, in 1999, the 10-year Treasury rose in yield from 4.65% to 6.45% (a 38.7% rise, making it the highest percentage change among all 204 years in the study!); yet, instead of falling, the S&P 500 rose sharply by 19.5%.

These data certainly do not indicate any "obvious" relationship between interest rates and stock prices. In other words, the belief that stock prices should fall because interest rates rise is not well supported by historical evidence.

4 Comments:

Anonymous Anonymous said...

Nice job on your blog! I am book marking your site for future reference.

I have recently created a book estate investing real
site. It pretty much covers book estate investing real
related stuff.

Stop by and check it out if you have time.

8:43 PM, October 12, 2005  
Anonymous Anonymous said...

Nice site. Check mine out if you can. investing for dummy

3:17 PM, October 24, 2005  
Anonymous xiaonanok said...

Welcome to our website for you World of Warcraft Gold,Wow Gold,Cheap World of Warcraft Gold,cheap wow gold,buy cheap wow gold,real wow gold,sell wow gold, ...
Here wow gold of 1000 gold at $68.99-$80.99 ,World Of Warcraft Gold,buy wow gold,sell world of warcraft gold(wow gold),buy euro gold wow Cheap wow gold,cheapest wow gold store ... ffxi gil buy euro gold wow wow gold--buy cheap wow gold,sell wow gold.welcome to buy cheap wow gold--cheap, easy, wow gold purchasing.World of Warcraft,wow gold Super ...
We can have your wow gold,buy wow gold,wow gold game,world of warcraft gold, wow Gold Cheap wow, Cheap wow gold,world of warcraft gold deal,Cheap WOW Gold ...

Welcome to our website for you World of Warcraft Gold,Wow Gold,Cheap World of Warcraft Gold,wow gold,buy cheap wow gold,real wow gold,sell wow gold, ...
Here wow gold of 1000 gold at $68.99-$80.99,World Of Warcraft Gold,buy wow gold,sell world of warcraft gold(wow gold),buy gold wow lightninghoof instock Cheap wow gold,cheapest wow gold store ...
ffxi gil wow gold--buy cheap wow gold,sell wow gold.welcome to buy cheap wow gold--cheap, easy, wow gold purchasing.World of Warcraft,wow gold Super ...
Wow gold- Gold for buy gold wow lightninghoof instock EU-Server: ...wow Gold EU: starting from 84,99?; 3000 WoW Gold EU: starting from 119,99?. wow Gold- Leveling Services: ...
We can have your wow Gold,buy wow Gold,wow Gold game,wow gold, Cheap wow Gold, Cheap World of Warcraft Gold,world of warcraft gold deal,buy cheap wow gold,Cheap WOW Gold ...

Here wow Gold of 1000 gold at $68.99-$80.99,World Of Warcraft Gold,buy wow Gold,sell world of warcraft gold(wow gold),Cheap wow gold,cheapest World of Warcraft Gold store ...

10:35 PM, March 19, 2007  
Anonymous Penny Stock Newsletter said...

I don't think that interest rates and stock prices move together. The thing that drives stock prices is earnings outlook and economic growth.

9:59 AM, February 01, 2012  

Post a Comment

<< Home