When Interest Rates Rise

“Rising interest rates … Now there’s a term we haven’t heard in a long time.” — Obi-Wan Kenobi

OK, Obi-Wan Kenobi didn’t actually say that, but millions of investors are suddenly thinking it. Earlier this month, the financial news was filled with hints of rising interest rates based mostly on comments by various Federal Reserve officials.

So, let’s say there is fire beneath all that smoke and we are entering a period of rising interest rates. What would that mean for the stock market overall and for various industry sectors? To answer that question, I took a look at nearly 30 years’ worth of data for the 10-year Treasury note, which is an important barometer for interest rates in general.

There were six significant periods of rising interest rates over this time frame: September 1993 to December 1994; the first eight months of 1996; the end of 1998 to January 2000; mid-2003 to mid-2006; all of 2009; and from August 2012 until the end of 2013. Rates increased anywhere from 25 percent to 100 percent during these windows.

And how did various areas of the investment landscape fare when rates where rising? Overall, pretty well. Growth-oriented investments, measured by the Russell 1000 Growth Index, were up an average of 19 percent (annualized), the S&P 400 mid cap index surged 18 percent and the overall market as measured by the S&P 500 gained an average of 15 percent. Sector-wise, technology stocks rose an average of 20 percent, materials jumped 18 percent and industrials rose an average of 15 percent. Financials, health care and energy stocks also rose, but at a slightly lower rate than the S&P 500.

Telecom stocks and REITs (publicly traded shares in commercial real estate holdings) showed very little growth during the periods of rising interest rates. Utility stocks fell an average of 1.5 percent. No surprises here. When rates go up, investors tend to flee from utilities and other debt-heavy industries for fear the cost of that debt will soar as interest rates rise.

What’s more, rising interest rates are a sign that the economy is expanding, which often sends investors on a chase for growth as opposed to investing in established dividend payers like utilities and telecoms. As rates climb, so do yields on new bonds, making them another competitor to utilities for the investment dollars of those looking for yield.

Remember, it’s important to keep a big picture perspective. If the Fed does raise interest rates in the near future, it’s because they believe the economy is growing stronger. That’s not a bad thing. The Fed currently sees an economy with healthy consumer sentiment, a robust housing market, and continued wage and job growth.

If rates do go up, they will have little immediate impact on the broad economy. It will be like sprinkling water on a hot iron. There will be noise and steam, but eventually things will settle down. So, don’t panic. Make sure you have some bonds with intermediate to short yields to provide stability in the face of stock fluctuations. And be sure that in your pursuit of income, you haven’t become over-invested in high yielding sectors, REITs or utilities.

Finally, remember that it’s big overarching market and economic themes that matter most. We are currently in the intermediate stages of a long-term bull market, part of a historic trend going back 100 years. We’re also in a short-term bull cycle within that longer-term trend. This double-bull cycle scenario typically delivers the strongest stock market returns, generating an average 107 percent gain over 753 trading days. There is good reason to believe the long-term bull cycle will last through this decade, perhaps until 2021, according to analysts at NDR, a leading institution research firm.

Given the above, you run the risk of losing considerable potential gains if you jump out of the market when rates go up. As Yoda reminded us, “Fear is the path to the dark side, and lost returns.”

Or something like that.

The original AJC article appears here.

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