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- Stocks actually have a "weak and inconsistent correlation" with interest rates, according to Bank of America Merrill Lynch strategists.
- They've been receiving lots of questions from clients following the market correction that was partly driven by fears of higher rates.
- Returns stay positive until interest rates cross 6%, and the probability of losses starts to increase as rates rise above 3%, BAML found.
Strategists at Bank of America Merrill Lynch say they have been fielding a lot of questions about the impact of interest rates on stocks.
Clients have likely grown more curious because of the market's recent correction, which was partially blamed on the fear of interest rates rising.
But BAML's study shows that there's no clear relationship between rates and stocks.
"Over the past 64 years, stocks have exhibited a weak and inconsistent correlation with interest rates (-11%)," Savita Subramanian, the head of US equity and quant strategy, said in a note on Wednesday.
"The relationship was generally negative for most of the 1960s through the 1990s (higher yields bad for stocks), a period during which the average level of rates was 7.5%. But since the turn of the century, the relationship was generally positive (higher yields good for stocks) a period during which the average level of rates was 3%."
Bank of America Merrill Lynch
And in case a client wasn't yet convinced, Subramanian pointed out that the best year for stocks in this cycle was 2013, when the taper tantrum spiked the 10-year yield by more than 100 basis points and the S&P 500 returned 32%. Moreover, periods when rates were rising coincided with higher stock prices almost 90% of the time, Subramanian found.
Higher interest rates do raise the discount rates that investors use to determine the present value of cash flows, which can crimp the valuations of risk assets including stocks.
But that's assuming all else is equal, Subramanian said. "One common offset to a rising risk-free rate (which drives the denominator in a discounted cash flow framework) is stronger growth (a higher numerator)," she said.
"Meanwhile, stocks remain cheap relative to bonds, suggesting that there may still be some buffer for valuations to absorb higher rates."
Still, these results don't create an excuse to be complacent about the impact of higher rates. A weak relationship with stocks doesn't mean none at all, and Subramanian screened more than 70 stocks that are historically hurt by higher nominal rates.
Also, Subramanian noted that while the stock market returns stay positive until interest rates cross 6%, the probability of losses start to increase as rates rise above 3%.
That's similar to what Jonathan Golub, the chief US equity strategist at Credit Suisse, told clients in a note on Monday. He found that stocks move positively with yields until the 10-year yield reaches 3.5%, based on a trendline of the S&P 500's performance on days when interest rates rose.
Credit Suisse