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  • Writer's pictureBridget Sullivan Mermel CFP(R) CPA

Interest Rates & Stock Performance


Join John and Bridget as they delve into the relationship between interest rates and stock performance. Discover surprising insights that challenge conventional wisdom. - Historical data on interest rates and stock market performance. Topics include:


- Analysis of Ben Carlson's blog findings and the S&P 500 returns

- The impact of low vs. high interest rates on stocks

- The importance of a diversified portfolio

- Conventional wisdom vs. actual trends in financial planning


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Alliance of Comprehensive Planners: https://www.acplanners.org


John's firm website: https://www.trinfin.com



TRANSCRIPT:


John: Higher interest rates have historically caused bad years in the stock market, right? Well, that's not necessarily the case, and we're going to dig into some of the facts and some of the fiction on today's episode of Friends Talk Financial Planning. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.


Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. And hey, John, we're trying to get to 1,000 subscribers and higher. And our viewers can help us out by hitting subscribe. That helps more people find us. All right, John, so I’m really interested in this data. I love it when you bring up data and this interest rate versus returns fits into that category. One of the things I think we really like on this show is when things are counterintuitive, because we think, in general, high interest rates hurt returns. What are your thoughts?


John: Yeah, it’s counterintuitive, but it's also a matter of conventional wisdom. What do we hear, and what are the facts? And sometimes those things match up. And that's right. It makes sense. But there's a lot of times where, geez, how I think about this, or what my gut tells me is not exactly right. And I was reading an article by Ben Carlson from his blog, A Wealth of Common Sense, I think it's called. We'll put a link in the show notes. If you don't pay attention to Ben's stuff and you're interested in this, there’s a ton of information here.


But the topic was about, hey, interest rates are higher. Does that mean bad things for the stock market? And yeah, that sounds like that's about right. That's historically what it has been, but he put together some data. We'll pull up a chart. And let's just take a look at what this chart says; let’s walk through it. And then, Bridget, I'm interested in your takeaways and what you see in this. So the “10Y” at the top, that's the ten year treasury bill. And that's not an exact measure of interest rates or inflation, but that's our proxy, that’s our benchmark.


So when the ten year treasury rate is at various levels, what does the stock market do? That’s what this chart is telling us. And you can see the dark blue bar line. That's the one year after when rates are at 2%. What's the next year? A lighter blue. What's the next five years? The orange. My eyes go to that orange bar because number one, it's bigger, but it also outlines what the next five years will look like. And then in the chart here on the left-hand side going up and down, that's the percentage of the S&P 500 over that time period.


And then on the bottom going left to right, it's what were the ten-year treasury and interest rates at? So on the far left, they're less than two, something in the zeros or ones. And then the second one, something between two and three. And then in the threes, between three and four and so forth. And then the outliers, of course, are the things under two and the things over eight. These can kind of get lumped together. So that's what we're looking at here. Let's maybe focus on those orange bars, the five year returns of the S&P 500 at various times when the ten-year treasury bill is at various rates. What’s your takeaway in looking at this chart?


Bridget: I’m looking at it right here and geez, this whole lower than 2% is looking good.


John: Yeah.


Bridget: That lower than 2% interest rate seems to help the stock market. And then the rest of it is a wash. I don’t see any pattern here. And when interest rates are higher than 8%, it’s surprisingly not that bad.


John: Yeah. Interesting, isn't it?


Bridget: So with high interest rates, people seem to make their adjustments. That's what this says to me. It's surprising. It's not as good as when it's lower than 2% as far as the stock market, but it's not that bad.


John: Yeah.


Bridget: And you're not just getting the stock market returns, but you're taking advantage of some of those bond returns that are going to be higher.


John: Right. Especially as you think about a balanced portfolio. Of course, with super low interest rates stocks have done better, but the number two place is not then at the 2% level or in the 3% range or in the 4% range. The number two place for stocks is in that 6% range.


Bridget: Yeah.


John: And the number three place is in the 4% range and then the 5%. So number one is under 2%. Hey, we're rooting for interest rates to be super-duper low, and if they're not super-duper low, we want them in the middle at 4% to 7%. Isn't that interesting?


Bridget: Well, but it's not telling a consistent story. To me, it looks like lower is better for stock returns, but I don't know, this 8% is not that bad, considering you're probably making some interest on top of that.


John: Right. And look at where we are today with treasuries and bond rates in general. We can all remember two, three, four years ago when CDs and the five- and ten-year treasuries were paying 2%. You're not getting any interest. And that's been that way for a long time before that. In a place like this, the common complaint of retirees, the people living on a fixed income, is where do you get interest? With bonds and CDs, you're not getting anything.  What are we at today? We've got several episodes on I bonds and bond ladders, and now we're talking in the 4%, 5%, 6% range. Hey, we're actually getting interest on that fixed income side of things.


Plus, these numbers on this chart here show that stocks tend to do pretty decent when ten-year treasury rates are in that range. Hey, you're actually getting both sides of it, not when it gets above 8%, but down in the 4% and 5% range. People are pretty happy to have 5% treasury bills and CDs these days. And that's one of those conventional wisdom things where it's important to look at the facts. Geez, when interest rates go up, that's bad for the economy, that's bad for stocks, that’s bad for businesses. Well, as you say, the story just doesn't show that. I think it's purely an anomaly that the 3% range and then the 7% range happen to be the lowest.


I don't think that tells us any story that 8% and higher is good, but 7% is bad. That's not the story I take from that necessarily. It's just, hey, we don't know. It's not necessarily a bad thing; it's sort of a neutral thing. And you and I were at a conference here not too long ago, and I remember that this was one of the things I took from hearing the speakers talk about some of these sorts of issues. Are interest rates important? Yes, they're important. It's not to say they're not important, but they're just one of many, many things and one of many, many factors.


It's like putting eggs or flour into cookies. I don't taste eggs when I eat cookies. Are there eggs in there? Yeah, they make it taste good, but it's one part. It's not like putting garlic in cookies. Hey, you put garlic in a cookie, it probably wouldn't taste so hot. It's a different story. It's all these different things that go in to make up the whole. So it's not like we can say, “Oh, interest rates are high, so stocks will be bad.” That's not the answer, but it feels like that sometimes when you look at given sets of data or read different things.


Bridget: Yeah, I totally agree. And I found that people's idea is the stock market is bad if the interest rates are high, and that's just not the case.


John: Right.


Bridget: Of course, it can be better when interest rates are low. That seems clear. But then you’re earning no interest on anything you’re trying to earn some interest on. This actually argues, I would say, for a diversified portfolio that includes some interest earning and some stocks.


John: Yeah. And I think that’s what most people have. Not many people have everything on one side of it. And you might think that if interest rates are way down, stocks look good, but then the rest of your portfolio, just like you said, doesn't look that good. I do think it's interesting that as we look at the graph, the bulk of the good returns is in that middle range of 4% to 7%. Historically speaking, what does the ten-year treasury typically go for as far as rates go? Somewhere in that 4.5% to 6% range, depending on the timeframe you look at. Usually, the treasury is in that 5% range. And what happens?


Stocks usually do pretty well when treasuries are in that 5% range, which is congruent with all the other things that we've seen over the years. But it just doesn't feel like that when you start focusing on any one thing. And when you can step back and have that bigger picture, you can go, “Maybe higher interest rates are bad for stocks. But maybe higher interest rates are actually good for stocks.” And that shouldn't change our planning and your decision making as an individual. It’s not all about those external factors, interest rates or this or that. It's about how do you reach your goals? And focusing internally rather than externally is, as always, the key to success.


Bridget: Absolutely. This seems like a great place to wrap it up. I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.


John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. Both Bridget and I are taking on new clients. We'd love to hear from you. But if you like what we talk about on our show and you'd like to find an advisor in your area, we're both members of the Alliance of Comprehensive Planners, which is a group of nationwide, fee-only, tax-focused financial advisors. To find an ACP advisor in your area, you can check out acplanners.org.


Bridget: And don't forget to subscribe.

 

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.

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