[Ed. note: for a change, we are presenting a post by a stock market bull below, namely Sid Riggs, via Bonner & Partners. It is always refreshing to see a well-reasoned argument that is contrary to one’s own opinion – after all, no-one really knows the future and Sid makes a number of important points, which deserve to be given attention. Sid is actually quite correct with respect to the historical correlation between rate hikes and the stock market. The strongest counter-points we can offer are these: 1. the market is extremely overvalued, 2. long-term positioning data show that everybody is “all in” already and 3. a rate hike would not be the first act of tightening monetary policy, but in fact the third. Act one was the “taper”, act two the cessation of QE. Given the paramount importance of money supply growth to stock prices, we would argue that the decisive factor will be whether or not commercial banks decide to expand credit.]


A Powerful Lesson from the Recent Past

There is a lot of lip service being paid to the stock market crash that we’re supposed to expect once the Federal Reserve starts raising rates. Every time we get close to a regularly scheduled Federal Reserve statement, financial pundits pontificate about the nuances of what the Fed chair might say, not say, or imply. It’s like clockwork.



But one theme remains constant: Any tightening of the Fed’s easy monetary policies will spell impending doom for the easy-money-addicted stock market. The only problem, though, is that historical facts just don’t support the fear. In fact, there are opportunities for investment out there no matter what rates do…

First, let’s rewind a moment to late 2013. Just about every talking head in the financial media was sure that stocks were going to crater as soon as the Fed announced even a whiff of a taper in its bond-buying program. And then the Fed began …


1-SPXThe S&P 500 and the “tapering” of QE3 – click to enlarge.


On December 18, 2013, it announced it would start to taper its aggressive bond-buying program to $75 billion a month beginning in January 2014 – and what happened? The S&P 500 rallied to a then-record close of 1,810.65. Oops, I guess traders forgot to listen to the talking heads. And there was a good reason for that:

Traders are constantly taking in all available information and continually adjusting positions accordingly. So when the Fed announced initial plans to taper, the news had likely been priced into stocks for weeks – if not months. And the fact that the taper was just $10 billion a month was a pleasant surprise.

Fast-forward to September 2014. The Fed closed its QE3-related bond-buying program – and the markets had gained 9.5% from the initial December 18, 2013, announcement. Traders who swallowed the taper-tantrum red pill and moved to cash in December 2013 had a lot of catching up to do – and that means they are likely going to have to take on excessive risk to make up the difference.

But as soon as the Fed ended QE, the dialogue shifted to “rising interest rates.” The almost unanimous opinion is there will be a sell-off because the market, the economy, you name it, are all addicted to cheap credit. I don’t buy it – and I have the hard facts to support my position.


The Pundits Have It Wrong

The chart below demonstrates S&P 500 performance vs. the fed funds rate going all the way back to December 1, 1971.


2-FFRSPXThe Federal Funds rate and the stock market usually rise together, at least for a while.


It might be hard to see what’s truly happening in that chart, so I broke it down in the table below, based on seven sample periods when the Fed was raising the fed funds rate.

Six out of the last seven periods during which the Fed was raising rates, the markets actually went up – gaining an average 13.47% during the rising-rate periods.

And, as you can see below, the only time the S&P 500 didn’t increase in value alongside rising rates was all the way back in the early 1970s, when the fed funds rate increased a whopping 9.21 percentage points, from 3.71% to 12.92%.

I don’t know about you, but I’m not too concerned with the Fed raising rates to nearly 10% anytime soon.


3-table0828Details of the sample sets highlighted in the chart


The Great News for Equities

What’s lost in all the chatter about the Fed increasing rates is one simple point: The Fed typically only raises rates when it believes the economy can absorb the increase – and even then, it’s usually slow to finally increase rates.

When it does, the increases come in small increments that the market can digest… at least to a point, then the cycle reverses, the economy goes into a recession, and the Fed lowers rates again.

I don’t see any reason to think Team Yellen is going to break with tradition and raise rates so fast as to kick the feet out from under the U.S. Economy. Granted, once the Fed does increase rates you can expect a period of volatility – but don’t read too much into it.

Of course there’s going to be volatility as institutional traders around the world adjust their respective positions based on risk models that use the fed funds rate as a critical input.

And then there is the correlation of 10-year U.S. Treasurys to the fed funds rate… The chart below demonstrates an 89.94% correlation between fed funds rates and U.S. 10-Year Treasury rates.


4-FFR10yr10 year treasury yields and the FF rate – historically often (but not always) aligned.


Of the data so far, the chart above might be the most important because of how it correlates to the first rule of money: Capital always goes where it’s treated best.

If 10-year rates are “increasing” it’s because traders are “selling” – and that freed-up capital has to go somewhere. I think it would follow historical examples and move into equities.


The Counterargument Is Wrong

Could you make the argument that “This time it’s different,” because the Fed has injected so much liquidity into financial markets? Sure you could. But it would represent a break with historical norms and I’m more interested in historical statistics than unproven hypotheses.

Could you make the “All that liquidity is going to eventually create massive inflation” argument? Sure you could. But inflationary periods have typically favored stocks, so that would likely favor equities.

Finally, could you make the “Geopolitical risk will drive a flight to safety into U.S. debt and out of equities” argument? Yes, of course, you could. But that condition would likely be temporary. Eventually the 89.94% correlation between 10-year treasuries and the fed funds rate would normalize and 10-year rates would likely rise, which favors equities.

So when the Fed does raise rates – and the inevitable short-term rate riot occurs – we’ll use the volatility to go shopping.


Charts and tables by: StockCharts, Bonner & Partners


The above article originally appeared at the Diary of a Rogue Economist, written for Bonner & Partners. Bill Bonner founded Agora, Inc in 1978. It has since grown into one of the largest independent newsletter publishing companies in the world. He has also written three New York Times bestselling books, Financial Reckoning Day, Empire of Debt and Mobs, Messiahs and Markets.




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5 Responses to “Why I’m Hoping for a Rate Increase”

  • serros:

    For me the global WW problem is DEBTS, by Hundreds of Trillions, everywhere, in all countries…
    Politicians discovered a new way of “saving the World” by printing money, but only for the Big Banks; with interest rates at zero (or below: ie in my country Switzerland).
    With this system, the global economy did not pick-up for years, bubbles are everywhere and confidence in the real economy is fading away.
    When the FED will start increase interest rates (many pension funds are bankrupt, with capital return based on annual 8% interest in US), what will happen?
    So now, are the current levels of stocks sustainable? Not so sure!

  • No6:

    Good Jobs data later this week is bad news for the market !!!??!!!

    Great job the Fed has done. The whole stock market is now a farce.

  • Crysangle:

    For a contrary perspective , according to the second chart , rates have traditionally accompanied rises in market value and reduced as market value declines . From that viewpoint they are designed to act as stabilizers to market volatility … except on the most recent rise in the market no pursuit was made by hiking rates . Is it not possible that money was treated best, under that circumstance , by migrating to the market due to the simple base limit on returns on sovereign debt ? Under that view money might choose a more rewarding safety of national debt than an overinflated market that finds it must pay more to maintain its level .

    I am not a technical analyst and am only including the parameters affecting the markets that I do understand . From a lay view , how is it possible to guarantee cause and effect where correlation occurs , simple timing is quite easily ‘arranged’ in the real world in the sense that it may easily confuse what appears to be the initiative as a result instead.

  • Kafka:

    Odd thing that- for a supposed free-market economy we have control of interest rates under the thumb of an America Politburo. 7 plus years of free money to their friends and little has happened to create a new investment climate in the USA. Only pushing up of paper prices. And now comes the crash.

    The Fed is supposed to be the referee, not the decider of the game. Let interest rates find their own level, between many buyers and many sellers, and I can guarantee you they won’t be zero.

    It is the Fed that has extinguished moral hazard.

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