What Returns Do You Get When Interest Rates Are High?
Key Takeaways
Rising interest rates have been framed as one of the factors for stock market volatility, drawdowns, and other negative outcomes.
But certain opportunities arise during an interest rate hike that rarely occur otherwise e.g. Better returns on ‘risk-free’ securities like MAS 12 month T-bills.
Reviewing historical data, there is no clear relationship between high/low rates, and even changes in interest rates, with stock market returns.
Instead of watching closely and worrying about single-facet factors like high or low interest rates, consider the reasons why you started investing in the first place. What other assets have the same opportunity to grow your wealth and keep up with inflation?
The four most dangerous words in investing are, it’s different this time.
— Sir John Templeton
An internet search on “Rising Interest Rates” brings up results with headlines such as “negative impact on stocks and investments”, “expensive debt”, and “cooling demand for goods and services”.
There are also many investment strategists who have highlighted that we are in a new environment now, with higher inflation and interest rates — which necessitates a new style of investing. However if the quote at the beginning of our article made by Templeton in his 1993 book is anything to go by, this type of thinking has led to some of the most expensive mistakes made in markets throughout time.
It is not necessarily doom and gloom every time interest rates rise. Savers should be rejoicing as they have not seen deposit rates at these levels for many years. The chart below shows the yield on MAS 12 month T-bills over the past 3 years. It has risen from a paltry 0.37% to over 4% in a quick span of time.
‘Risk-Free’ Securities & Their Impact On The Stock Market
Because of the how interest rates have moved upwards in 2022, investors are being offered a gift of relatively high yields on what can be deemed as “risk-free” securities. Of course the caveat to this is that at the moment, inflation is trending above these savings rates and would still erode your purchasing power.
Revisiting some of the earlier arguments about high rates affecting investments — let’s look at the relationship between high rates and the performance of the stock market. In theory, it makes sense that a high “risk-free” or deposit rate could impact the demand for stocks and other risk assets. Why would anyone want to place their money in such investments at higher volatility when they could sit back, relax and receive a decent yield?
The chart below from the IMF shows the deposit rates in Singapore since the late 70’s and we have not seen a rate higher than 2% since the dot-com bubble in 2000.
Given how high deposit rates (and the corresponding base interest rates) were in the 1980’s, it would seem that stock market returns were unlikely to be good during that time.
Let’s take a look at the data. The table below summarises the average deposit rate and the Compounded Annual Growth Rate (CAGR) of global stocks (in SGD) throughout the recent decades.
Reviewing The Evidence
An interesting observation emerges. In the 80’s when interest rates were very high, stock returns were also high — way above average in fact.
In the 90’s stock returns fell to more average levels, even though interest rates were still slightly elevated. Yield levels dropped drastically in the 2000’s, yet stock market returns were awful. In the latest decade when interest rates were still at rock bottom, stock market returns were back to average levels again. There is no clear relationship between high/low rates and stock market returns.
Perhaps it is not the level of rates, but maybe that stock returns are affected if rates are rising or falling? Again, let’s review the data.
The chart below uses regression data to attempt to find a relationship between the changes in various types of interest rates or bond yields and the price of the stock market. The green down arrow on the left of all the y-axes denotes falling rates or yields. The red up arrow on the right of all the y-axes denotes rising rates or yields. The diamonds plot whether stocks are positive or negative during those periods.
Again, there is no discernable pattern between changes in interest rates and stock market prices.
Instead of being obsessed or overly worried about whether high or low interest rates affect your investments, consider instead the factors that drove you to start investing in the first place. We cannot know whether we could be in a decade where returns could be negative, but consider the alternative: What other investments have the same opportunity to grow your wealth and keep up with inflation?
Still have some concerns over how markets are doing? Schedule a meeting with your advisor or contact us for a review of how we can put those fears to rest.
