When interest rates reverse their long-term course, it’s a significant event. In fact, this tends to happen perhaps three times in a lifetime. So, as long-term bond yields rise after a 33-year drop, we are witnessing a major event.
However, with the rise in yields comes worry. Higher interest rates do raise business costs and discourage consumer borrowing, thus cutting profit prospects. But will this rise in rates push the stock market into decline? It doesn’t seem to happen that way.
In the past two occasions that interest rates hit bottom after a long secular drop, stocks began a secular bull market. These occasions were long separated in time, happening in the early 1940s and late 1890s.
Long-term bond yields had bottomed in 1941 after a 20-year drop. The following year, Wall Street prices hit an historical low – and stocks began a secular bull market that lasted to 1972.
In the 1890s, interest rates started to rise, having dropped for 30 years. Wall Street also rallied, beginning a secular bull market that endured until 1929.
In brief, the start of a bond bear market (bond prices drop; interest rates rise) seems to equate with the start of a secular bull market for stocks.
Primary evidence for this comes from the U.S., the world’s largest financial market, both now and in the 1940s, and a growing financial power more than a century ago. Interest rate trends are international, though, so what happens in the U.S. also is happening in Canada, the U.K. and elsewhere.
The current upturn in bond yields looks clear. Using 10-year U.S. Treasury bonds as the indicator, yields dropped as low as 1.43% last year – the lowest ever recorded. This year, the 10-year yield has risen as high as 2.64%, the highest since early 2011. When the 10-year yield rises above 3%, the trend reversal will be conclusive.
If there’s anything out of joint with the parallel between today and the events of the 1940s and 1890s, it’s this: the stock market is rising already – and has been since early 2009. This is a much wider separation in time between the interest rate and stock market lows of the 1940s and the 1890s.
To be sure, some analysts claim a secular bull market is underway. As of the end of July, Wall Street had risen for 53 months, longer than the rising phase of a typical four-year bull market cycle.
The extraordinary feature of the bond bull market that started in 1981 and now is ending is its extremes. Bond yields reached double-digit rates at their climax in 1981, the highest in modern times. The 10-year T-bond yield peaked at 15.84%.
As mentioned, at the other end, long-term yields dropped to the other extreme. This possibly was a forecast of things to come; or, perhaps, it was a one-time aberration of the financial markets.
Contrast these trends with the past highs and lows. U.S. government long-bond yields averaged 2.2% in 1899, then rose until 1920 (a bond bear market). Yields peaked at an annual average of 5.3%, then started to drop, launching the bond bull market that lasted until the 1940s.
In 1941, the average yield on long-term U.S. government bonds dropped to 1.95%. Three-month T-bonds provided a negative yield – as they have recently. That was the end of a bond bull market.
Now, we have its successor.
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