Impact of rising interest rates on the stocks and bonds

If you watch even a little bit of news, then you would have seen headlines that have attributed the recent fall in the markets to everything from crude prices, IL&FS, rising interest rate environment to the upcoming elections.

Fed raising the rates is actually a big deal, but what does it mean to you as an investor? Vanguard published a really insightful report which showed the impact of interest rate hikes on the returns of S&P 500 over 11 periods where interest rates were on the rise. Although there isn’t India specific data, a lot can be extrapolated from this.

Here are some really important highlights from the report

During the 11 periods of rising rates that have occurred over the past 50 years, annualized total returns have been broadly positive and in line with historical averages.

Many investors believe that rising interest rates are a harbinger of poor stock returns, and they have some solid reasons for thinking that. Higher rates make bonds relatively more attractive versus stocks. And higher rates slow overall economic growth, which weighs on corporate profits and stock prices. Financially savvy investors might also note that higher interest rates lower the value of future corporate earnings, thereby reducing their present value.

The historical research we’ve done, however, doesn’t show a pattern of falling stock prices during rate-hiking cycles. In fact, hiking regimes often take place when the economy is performing strongly and earnings growth is robust, and therefore stocks tend to perform respectably during those periods.

As the graphic illustrates, in the 11 periods of rising rates we looked at over the past 50 years, stock market returns were positive in all but one of them. And even including the –15% return for the period in 1974, the return of stocks across those periods was in line with the 10% average for stocks from 1925 through 2017.

Full report