Higher Rates Suddenly Fit Bull Case on Stocks

  • Small-caps benefit most historically, then midcaps, S&P says
  • Sectors that report strong profits, pay high dividends do well

Too Early to Gauge Market Rally, Voya's Reinhard Says

If nothing else, the last two weeks have been a lesson in the hazards of pat narratives. Exhibit A is rising interest rates: are they good or bad for stocks?

Going by this week, you’d have to say stock investors can manage in their presence. From an intraday low six days ago, the S&P 500 Index has rallied 7.4 percent, putting it on pace for the biggest weekly gain since 2014. All that as 10-year Treasury yields went from 2.85 percent to nearly 2.90 percent now.

It’s a long way from two Fridays ago, when bond rates significantly lower than today’s were enough to spark an equity selloff that became the fastest correction in half a century. Call it an overshoot, call it fickle psychology -- but don’t call it a break with how the two markets have usually interacted.

Strategists at S&P Dow Jones Indices weighed in on the question Wednesday, noting that while there’s been concern in the markets about the future of Federal Reserve policy, equities historically have thrived, rather than suffered, when interest rates climb.

“The first reason to love equities in rising rate times is that they have gained significantly,” Jodie Gunzberg, managing director and head of U.S. equities at S&P Dow Jones Indices, wrote in a blog post on Wednesday. “Since 1971, the S&P 500 [Total Return] has gained about 20 percent on average in rising rate periods, has gained 8 of 9 times and has gained nearly 40 percent twice with less than a 4 percent loss for its worst rising rate period.”

In addition, stocks benefit from overall appreciating asset values during these periods. “This makes sense because interest rates may not drive equities but both can rise concurrently from the environment that lifts them,” she wrote.

Small-cap stocks have typically fared the best during periods of rising rates, gaining 7.3 percent for every 100 basis point increase. Meanwhile, mid-caps have added 5.9 percent and large caps have advanced 2.5 percent. Although every sector, size and style gains in such a situation, Gunzberg advised investors to “look to the sectors reporting strong profits and paying high dividends to perform in this rising rate environment.”

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