Interest rates have to go higher.
Almost everyone knows that.
But the real question on everyone’s mind is: will higher rates kill the bull market in stocks?
There’s a strongly-held belief that higher interest rates always work against stocks.
But that’s only half true.
The direction of interest rates is important. That’s what everyone focuses on.
But the level of interest rates is just as important. And this aspect of the relationship between interest rates and stock prices is overlooked by most.
Consider this chart, published consistently in J.P. Morgan’s Quarterly Guide to the Markets:
The chart plots the correlation between weekly stock returns and interest rate movements. It answers the simple question, “Do rates and stocks typically move in the same direction (positive correlation) or in opposite directions (negative correlation)?”
The answer is: both.
As I said, the correlation between stocks and rates depends on the level of interest rates, just as much as the directional trend.
When interest rates are above 5%, an upward trend in rates has historically weighed heavily on stock prices. This is the story most investors are told… higher rates make borrowing costlier, cooling the economy and investors’ expectations for stock returns.
But when rates are below 5%… an upward trend in interest rates has acted as a tailwind for stocks. Stock prices have historically moved higher, alongside increasing interest rates, while rates are under the 5% threshold.
Rates are under 5% today.
The trend of rising interest rates will indeed act as a headwind for stocks… eventually. But it could be a while longer before that headwind kicks in.
Until we hit the 5% threshold, we could easily see stocks continue to rise alongside interest rates.