It appears that one of the reasons that the Dow Jones Industrial Average declined 2% during the week ended June 21 (and was down 4% on Wednesday and Thursday alone) was investor concerns that interest rates, which have already begun to rise, will continue to go up in 2013 and 2014. These concerns were triggered by the Chairman of the Federal Reserve Ben Bernanke's comments that the Fed plans to slow its bond purchases over the next year and to end this program in 2014 if economic growth continues to strengthen.
I believe that investors reacted negatively to these comments in part because of worries that higher interest rates actually could slow economic growth and put an end to the bull market. Such concerns may be overdone, based on recent stock market history. Here's why.
I looked at interest rate and stock market performance as far back as 1950 to determine whether rising rates and a slumping stock market go hand in hand. I used the rate on 10-year Treasuries as my measure of interest rates and the Dow Jones Industrial average as my proxy for the stock market.
During the 63-year period from the end of 1949 through 2012, 10-year Treasury rates increased in 35 years and in 28 of those 35 years (or 80% of the time) the stock market was up. Moreover, the average increase in the Dow Jones Industrial Average in the 28 up years was more than 16%. These results suggest that expectations of higher interest rates, rather than being a reason to sell stocks, may, in reality, be a reason for optimism about the outlook for stock performance.
Why stocks have performed so well in the face of rising interest rates is unclear, although one possibility may be that rising rates are a sign of a strengthening economy that is boosting demand for capital. Assuming that stronger economic growth is likely to translate into higher corporate earnings, this can be a recipe for stock market gains.
While past stock market performance during periods of rising interest rates is encouraging, there is, of course, no certainty that this pattern will repeat. After all, in seven of the 35 years cited, the market declined. Also, the U.S. and world economies are more integrated today than ever before and, as a result, what happens overseas can affect economic growth here at home. Some analysts mentioned investor worries about the possibility of a slowdown in China's growth as another factor in last week's stock market decline.
I believe that investors reacted negatively to these comments in part because of worries that higher interest rates actually could slow economic growth and put an end to the bull market. Such concerns may be overdone, based on recent stock market history. Here's why.
I looked at interest rate and stock market performance as far back as 1950 to determine whether rising rates and a slumping stock market go hand in hand. I used the rate on 10-year Treasuries as my measure of interest rates and the Dow Jones Industrial average as my proxy for the stock market.
During the 63-year period from the end of 1949 through 2012, 10-year Treasury rates increased in 35 years and in 28 of those 35 years (or 80% of the time) the stock market was up. Moreover, the average increase in the Dow Jones Industrial Average in the 28 up years was more than 16%. These results suggest that expectations of higher interest rates, rather than being a reason to sell stocks, may, in reality, be a reason for optimism about the outlook for stock performance.
Why stocks have performed so well in the face of rising interest rates is unclear, although one possibility may be that rising rates are a sign of a strengthening economy that is boosting demand for capital. Assuming that stronger economic growth is likely to translate into higher corporate earnings, this can be a recipe for stock market gains.
While past stock market performance during periods of rising interest rates is encouraging, there is, of course, no certainty that this pattern will repeat. After all, in seven of the 35 years cited, the market declined. Also, the U.S. and world economies are more integrated today than ever before and, as a result, what happens overseas can affect economic growth here at home. Some analysts mentioned investor worries about the possibility of a slowdown in China's growth as another factor in last week's stock market decline.
