With interest rates rising in 2022 and the start of 2023, 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/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 between 1970 and 2022, stocks rose during 7.5 of them (0.5 because during in 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.
Here is the updated chart which shows 2022 into 2023.
Here the increase in interest rates was correlated with a decline in the S&P 500. Therefore the stock market has risen 7.5 times out of 11 periods of rising rates. Since this is an ongoing issue, we’ll see how it turns out. If interest rates continue to rise, the stock market could rise with it, or the stock market could stay flat or fall.
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 100 years, the S&P 500 has risen about 10.3%/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 4.25-4.5% in the US as of January 23, 2023. The following chart indicates there’s a 98.6% chance that rates will be 4.5-4.75% following the February 1 2023 Fed meeting, and a 1.4% chance interest rates will be 4.75-5%.
The tools provide futures Fed meeting dates. Click to see what rates are expected to be at various points in the future.
But as stated, I would much rather focus on price action and tendencies in price.
This thread looks at historical stock market declines and how often they occur.
Some historical context. Declines of 15% in the S&P 500 are common.— Cory Mitchell, CMT (@corymitc) April 30, 2022
This thread shows all the 20%, 30%, 40%, and 50%+ declines going back to 1872 so you know what’s possible, the probabilities of various events, and can thus prepare.
First the 15% declines (red brackets) pic.twitter.com/EzQVplxEOX
I prefer looking at this type of data, and the current price action, to make my trading decisions. Basing trading decisions on interest rates has pretty much been a coin flip in the past. And more often than not, you actually want to own stocks while interest rates are rising. That is just as logical since it shows the economy is doing well (if you need logic for your trades…I would steer clear of it. Markets aren’t always logical).
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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.