Here is a dramatic chart:
It provides a complete history of the trajectory of interest rates over the last sixty years—and also the backdrop for why there’s so much ado about rates today. It also explains the consensus sentiment that there is only one direction for interest rates to head. We have no desire to enter the pervasive discourse around the timing and pace of the expected rise in interest rates. But we can suggest three important things that will not happen when interest rates do rise.
First, rising rates won’t foretell the direction of the stock market, as the next chart illustrates.
Conventional wisdom is that rising interest rates are bad for equities. But in the last 25 years, the presumed relationship between equity performance and interest rates has been severely challenged.
Second, rising rates won’t foretell whether stock market dispersion will widen. Dispersion is a measure of the degree to which the components of an index perform similarly. If the components are tightly bunched, dispersion will be low and, other things equal, active managers will be challenged to add value by stock selection.
Dispersion rose in July, and may continue to do so. But as the historical data show, there is no reliable relationship between changes in dispersion and changes in interest rates.
Finally, rising rates won’t foretell the performance of factor indices. We examined several pairs of nominally opposite factor indices (e.g., growth vs. value, low volatility vs. high beta, etc.). In no case is there reliable evidence that interest rate changes have an impact on the relative performance of factor indices. The chart below highlights this for the S&P 500 Low Volatility and High Beta Indices.
There will no doubt be many economic and market effects attributed to the rise in interest rates, when it comes. This trifecta serves as a good reminder that analyzing the behavior of the equity market involves more than just the Fed’s decrees.