One of the most difficult things for budding investors to understand is the relationship between the bond market and the stock market. If you listen carefully through the cacophony of financial pundit prognostications you will discern that the primary reason the stock market is powering up this year is because the Fed continues to buy treasuries and mortgage-backed securities to the tune of $80 billion a month–Quantitative Easing (QE)– keeping liquidity high and bond rates low. And, that is, for the most part true. (See my previous post: Why the Fed and Monetary Policy Matter-Made Simple in the Arizona Republic.)
But the punditry volume increases when the discussion turns to how the stock market will perform when the Fed steps back from QE and the inevitable rise in bond rates begins. That debate ratcheted up in the last week as investors worried that the Fed would begin to “taper” their QE and bond rates would rise. (It should be noted that treasury bond rates have risen from a recent low of 1.6% for the ten year bond to 2.175% at today’s close.)
So can the stock market continue to perform in the face of rising interest rates? Generally the conventional wisdom would say “no”–as bond rates rise, the stock market declines and vice versa. But, during the 1950’s and 1990’s the stock market continued to perform well in the face of rising interest rates. According to the Leuthold Group as reported in Barron’s this last week, in the 1990’s the Dow Jones Industrial Average (DJIA) generated an average annual return of “15.7% when corporate bond prices fell” and rates rose (emphasis mine). During the 1950’s the returns were not as impressive but still robust. The DJIA rose 10.8% per year on average when bond rates increased.
Continue to build holdings in high-quality, industry leaders with steady growth. Most stocks are not expensive by any historical measure. Buy quality for the long-term. That is investing. The rest is just noise.