Global equity markets gained measurable strength during the week amidst what may have been construed as an unconventional window of opportunity. Federal Reserve Chair Jerome Powell delivered remarks that further bolstered the Fed’s tapering message. We learned of a more definitive development, and general timeline, of how the Fed will shift monetary policy to a less accommodative stance. Ironically, it has taken less substantive monetary policy news in the recent past to generate downside equity market volatility, yet that was clearly not the case this time. The Standard & Poor’s (S&P) 500 gained 1.54% for the week while international developed equities gained 1.87% (MSCI EAFE Index). For those investors questioning the validity of the stock market’s response, the answer remains notably more palatable than what it seems. Let us first recognize that the Fed’s tapering message has been the most announced monetary event in the history of the Federal Reserve. Not only is there zero shock factor, but the underlying reasoning for the need to limit accommodation is highly evident. Secondly, it’s important for investors to understand that it is not higher interest rates that can often derail bull markets; rather, it is unexpected faster interest rate hikes amidst a hiking process. This can often be a function of short-term core inflation or some other factor that is unforeseen (i.e., an event that can generate a mild shock factor). Be that as it may, the bottom line that deserves attention is the fact that maintaining equity market participation carries ample historical significance during periods of rising interest rates. This is most relevant within periods of a 10-year yield that’s below 5%. The data below showcases an updated view on a research piece we released last year, as its content remains highly relevant.
As the economic recovery gains stronger footing in the aftermath of COVID-19, the relationship between stocks and bonds provides ample historical evidence of what may come next. Although the possibility for short-term equity market volatility is always present, the long-term approach to participating across capital markets is one that favors stocks. The relationship is quite simple: yields gain upside during times of recovery and economic strength. As yields rise, bond prices fall, which is a testament to their negatively correlated relationship. Amidst such a simple relationship, however, historical data also reveals the benefits of investing in stocks during periods where the 10 year-yield gradually makes its way to higher levels. This becomes dominantly more opportunistic when the 10-year-yield remains in low territory, as is the case right now (as of August 2021). It may be difficult to envision a yield above 3%, but that is not something we should discount over the next two years. Stocks may stand to benefit relative to bonds.