When Interest Rates Go Up, Stocks Are Doomed, Right?
With stocks near all time highs and interest rates at all time lows, many people in stocks feel that we are on the brink of disaster.
Don’t let your emotions get ahead of the hard facts. It is critical that we carefully analyze the situation and make accurate assessments of what is taking place in our current financial markets.
It is very likely that stocks can still skyrocket from here. Everyone is worried about the outflow of money from stocks to interest bearing securities. Interest rates have been rising lately after hitting record lows, but does that mean that stocks have to fall? Actually, stocks have a great chance in doing quite well…
There’s a history lesson in here that gives us our best clues for the future…
The last time interest rates were this low was 60 years ago – in the mid-1950s. Back then (just like today), the Federal Reserve had manipulated long-term interest rates to keep them artificially low. That ended in 1951. Rates started to go up after that. They rose from 2.5% in 1955 to near 6% by the end of 1968.
The fear of course at the time conventionally, should have been to worry about stocks since people will start pouring their money into bonds and such. What exactly did happen to stock prices as interest rates went up? (It’s important because it’s what everyone is worried about today.)
Stocks actually held up quite well and especially didn’t crash…
As a matter of fact, we had one of the greatest stock market runs in all of history. The stock market soared nearly four times.
This is the essence of what I’m trying to get across… The last time U.S. interest rates went from 2.5% to 6%, the stock market soared fourfold.
Here’s what is even crazier… Your first assumption is going to be that stocks must have been really cheap to start with, right?
We’ll compare this a little more…
Stocks were no less expensive than they are today. Specifically, the stock market traded at a price-to-earnings ratio (P/E) of 13 at the end of 1955, about where we are today (based on Bloomberg’s estimated market P/E for the end of 2013).
Consider this… Do you know when stocks finally hit new highs after the stock-market crash in 1929? It took 25 years… stocks finally hit new highs in late 1954. So if you’d bought stocks at their all-time highs back then, you’d have made a fortune over the next decade. In hindsight, you’d look brilliant.
Stocks were never as cheap as they were in 1955 for the rest of that great bull market. During that entire late-1950/1960s run, the stock market’s P/E ratio stayed in the high teens. And stocks still soared nearly fourfold. Could stocks soar today, even though we are at new highs? Absolutely! The “new highs” story is all over the news. But please don’t let that worry you…
Even though the stocks were at all-time highs, they were not expensive based on what you got for your money compared to the investment alternatives out there.
In 2013, we have the exact same situation… It’s not just U.S. stocks that are cheap. Stocks around the world are cheap.