Why “Higher for Longer” Rates Haven’t Stopped Stocks

“Higher for longer” interest rates were supposed to be stocks’ albatross. But since October 2022, rates (short and long) have climbed with stocks. In our view, this illustrates fear over rates killing stocks is again overblown.

The widespread belief that high rates are kryptonite for stocks stems from a textbook way to value securities: using current interest rates to discount future cash flows. The higher the rate, the lower those cash flows’ present value—at least in theory. Hence, rising rates supposedly hurt growth stocks like Tech more because, theoretically, much of their earnings are further in the future. When interest rates rise, the present value of those distant profits shrinks faster—or so the thinking goes.

Problem is, this doesn’t regularly work in practice. Not for stocks generally nor Tech specifically. Exhibits 1 and 2 show the S&P 500 versus 3-month and 10-year Treasury yields, split for easier visualization into the generally rising rate period through the early 1980s and after. There are plenty of times besides the current cycle when stocks rose alongside rates—like in every bull market from 1954 to 1983.

Exhibit 1: Rates Don’t Dictate Stocks’ Direction (1954 – 1983)

Source: FactSet, as of 7/1/2024. S&P 500 price index and 3-month and 10-year Treasury yields, 1/4/1954 – 12/31/1983.

Or, for example, see rising rates during 2015 – 2019 and 2004 – 2006—they didn’t forestall bull markets in Exhibit 2. Now, 2009 – 2019’s long bull market—and 2020 – 2021’s brief one—featured low rates overall, but they didn’t cause stocks’ liftoff. And the wiggles and waggles higher in those stretches don’t regularly coincide with market weakness. Regardless, pre-2008, before the low-rate era began, few would have batted an eye over stocks and rates moving upwards together.

Exhibit 2: Rates Don’t Dictate Stocks’ Direction (1984 – 2024)

Source: FactSet, as of 7/1/2024. S&P 500 price index and 3-month and 10-year Treasury yields, 1/3/1984 – 7/1/2024.

As for higher rates being anathema to growth stocks, Exhibit 3 shows S&P 500 Tech sector relative returns against the fed-funds target rate. Again in previous cycles, purportedly “tighter” monetary policy didn’t stop Tech outperforming in 2015 – 2019 and 1994 – 1995. “Looser” policy in the early 2000s did nothing to stop Tech’s deflation. The mid-2000s’ rate hikes may seem to have stymied Tech, but this is mostly the aftermath of the Tech bubble—investors fought the last war throughout that value-led bull market. Regardless, there is no consistency: Rising rates weren’t auto bearish for Tech, nor were falling rates bullish.

Exhibit 3: Or Growth Stocks’—Like Tech’s—Relative Returns

Source: FactSet, as of 7/1/2024. S&P 500 Information Technology and S&P 500 total returns and fed-funds target rate, 12/31/1989 – 7/1/2024.

That isn’t to say rates have no effect on stocks. In our view, aggressive Fed rate hikes contributed to 2022’s bear market—alongside soaring inflation, Russia’s Ukraine invasion, sanctions and energy price spikes, all amid global supply chain chaos. Those hikes started with surprise, as officials talked up “transitory” price increases and rates staying low beforehand. We think the combination weighed on sentiment, helping drive 2022’s mild bear market. Then fears went too far, setting up positive surprise.

Rising rates can also disproportionately affect sectors reliant on them, like Real Estate, which is down -3.4% year-to-date, the only sector with negative returns.^[i] But for Tech? Generally cash-rich balance sheets in the sector make it more immune to rates, not less. And, increasingly, large Tech is quite profitable in the here and now—not just the far future.

This brings us to the main reason why high and/or rising rates aren’t anything to fear. Stocks don’t move on them, but on surprise. In late 2022 and early 2023, markets had pre-priced widespread fear of rising rates’ impacts (along with a bevy of other worries). Many went so far as to expect a 1970s redux. The fear went too far, irrationally depressing expectations—and making positive surprise easier to attain. Rates never soared into the mid-teens like then, sitting instead at historically normal levels—which isn’t terrible. Nothing here looks all that unusual when you take a broader look.

Exhibit 4: Rates Around Their Historical Average

Source: FactSet, as of 7/1/2024. 3-month and 10-year Treasury yields, 1/4/1954 – 7/1/2024.

Moreover, to say what may seem profane presently: There are some benefits from higher rates. One, savers are being rewarded more from interest income to the extent banks pass this through. Your emergency cash isn’t paying zero, which should discourage folks from seeking creative solutions to zero interest.

Now, some also suggest high rates on cash and bonds are so attractive they will lure people out of stocks. But they aren’t in competition. For long-term investors, stocks trounce cash (and bond) returns—and are far better at staying ahead of inflation. The reality, in our view, is this simply means cash reserves aren’t return-free. Regaining some purchasing power after inflation’s spike is fine, but for many, that probably isn’t enough to reach their long-term financial objectives.

Two, the higher bar for borrowers helps weed out speculative endeavors less likely to turn a profit down the line. To the degree this directs capital to more profitable projects, it lowers the likelihood of excesses building in the economy, extending expansion. Without excesses, there isn’t much reason for recession—its main purpose is to wring them out.

Lastly, another ancillary benefit from higher rates: It likely cuts down on central bank experimentation. The low-rate era had many monetary policy institutions around the world get, shall we say, creative. From quantitative easing and negative interest rates to YCC and TLTROs, never mind haphazard one-off reactions with disastrous consequences. The results are questionable at best and, we have found, usually counterproductive. And at their worst: panic-inducing and severely disruptive, turning major financial problems (to be sure) into full-fledged crisis while deepening and prolonging recession—unnecessarily.

When central banks are routinely undertaking large-scale extraordinary measures and unconventional policies because they find their typical toolkits lacking, the void of certainty that can leave may itself be destabilizing. Higher rates don’t guarantee a return to normal monetary policy operations—and less confusion—but we think they do make it more likely. And, in our view, boring central banking is better.

Overall, for investors, we see the same rate fears recycled ad nauseum for two years lingering today. But reality continues proving better than expected—which is why stocks keep plowing ahead.