Spring of 2012
It was the spring of 2012, and the market had just fallen about 5% to around 1,300 on the S&P 500, and interest rates on the 10-Year Treasury were below 2%. News stations around the country flashed their warnings of eminent danger in the markets. Many pundits in the media clamored for additional rounds of Quantitative Easing from the Federal Reserve. The European Union had just come off a year of economic fear related to Greece, Italy, Spain and other massively indebted nations. Fear abounded in the spring of 2012, but monetary medicine was plentiful as the Fed embarked on the final round of stimulus, purchasing $40bn per month of Mortgage Backed Securities. This injection of monetary medicine continued through October 2014.
Spring of 2013
It was April 30, 2013, the S&P stood at 1,597, and the 10-Year Treasury yielded 1.64%. Fast forward to December 31, 2013, the S&P stood at 1,848, and the 10-Year Treasury yielded 3.03%. Let’s phrase it differently, the last three quarters of 2013, the S&P went up over 15% in price, and the yield on the 10-Year Treasury went up by 139 basis points, almost doubling! Keep in mind: this almost doubling of the 10-Year Treasury yield occurred DURING the purchase window of MBS by the Federal Reserve. It looks like the equity markets can move higher despite higher interest rates. Dare I say that move up in interest rates occurred because of higher growth and inflation expectations?
Summer of 2016
It was the summer of 2016, the S&P stood at 2,173 (6/30/16), and the yield on the 10-Year Treasury was back down to a low of 1.46%. Dismal fears surrounding the most contentious election permeated every facet of America. Division, blame, anger, apathy, fear, and many other dour adjectives could be used to describe the mental climate of America leading into the Presidential election of 2016. Fast forward to 4/30/18, the S&P stands at 2,654 and the 10-Year Treasury yield is essentially 3%. It looks like the equity markets can move higher despite higher interest rates. Dare I say that move up in interest rates occurred because of higher growth and inflation expectations?
Bringing it all together
Since the spring of 2012 through today, the S&P price index has returned over 88%. The 10-Year Treasury yield has moved around from a low of 1.34% to a high of 3.04% during that same period. So what does that tell me? It tells me that markets care more about real things than Federal Reserve monetary medicine. The stock market is driven by the earnings power, cash flow, and growth rates of real corporations. Do not get me wrong, the market does care about the interest rate used to discount future earnings growth, which is why the P/E multiple has started to constrict this year. I do not think this is a bad thing, as we are able to buy equities cheaper on a P/E basis now, than when we started the year.
The Bottom Line
The stock market is a forward-looking instrument based on the real economy. Growth rates, corporate cash flow, and earnings, will all be the drivers of future long-term returns. So when pundits waive the red flag of fear over higher interest rates, remember they are likely indicative of higher future growth expectations as well, and that is not a bad thing!
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