With interest rates set to rise in 2022, how will that affect the stock indices like the S&P 500? Let’s look at the data to find out.
Logically, interest rates should affect stocks, since logically interest rates and inflation should affect consumer behavior. But the real question is, do interest rate increases (or decreases) have a reliable effect on causing stocks to either increase or decrease?
The answer to that…may surprise you.
How Interest Rates Impact Stocks
Stocks tend to move up slightly more often than they decline while interest rates rise.
But overall, the relationship between stocks and interest rates is pretty much a coin flip. Sometimes stocks move with interest rates/inflation and sometimes they move in opposite directions.
We can test this by adding the S&P 500 and US interest rates (orange) to a chart.
Out of 10 periods of interest rate increases since the 1970s, stocks rose during 7.5 of them (0.5 because during 77-79 stocks dropped for a year and then rallied for a year while interest rates rose).
So if anything, rising rates actually tend to be more associated with stock price increases than declines.
But other than that, the relationship between them is pretty tenuous. The correlation tends to flip-flop.
Should I Use Interest Rate to Analyze the Stock Market?
The data suggests not to. The relationship is pretty much like a coin flip as to whether interest rates will help you predict where the stock market is doing to go.
Trust the price action of what you’re trading. Don’t bring in other variables—like interest rates, or war/conflicts— to “aid analysis” unless you know how that variable performs (whether it actually helps).
When it comes to the stock market, common “truths” are often untrue or only partially true, but somehow went viral. This is often because it’s logical, it makes sense, but isn’t necessarily true/tested. If you are relying on something, it is worth doing some research yourself.
Over the last 150 years, the S&P 500 has risen about 9.3%/year, on average. Over that time interest rates have risen and fallen many times, yet the long-term price increase persists.
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Where can I find information on expected interest rate increases?
The CME FedWatch Tool is a great resource. It provides a probability for rate increases or decreases. For example, interest rates are at 0-25% in the US as of February 20, 2022. The following chart indicates there’s a 64.4% chance that rates will be 0.5-0.75% following the May 4, 2022, Fed meeting, and a 31.8% chance interest rates will be 0.75-1%.
By Cory Mitchell, CMT
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.