Debunking The Myths – Are Rising Interest Rates Bad For Stocks?

The latest week saw stocks sell off as the yield on the 10-Year Treasury soared above 4% and then rally as the benchmark government bond yield moved back below that level. While numerous factors inform short-term equity market gyrations, the natural conclusion drawn by many is that higher interest rates are bad for stocks and vice versa.

Hard to argue with such an assertion as all things being equal, stocks are more attractive when compared to a 3.95% Treasury yield than 4.05%, but all things are never equal. Indeed, the markets dipped on Wednesday on a slightly stronger-than-expected reading on the health of the manufacturing sector that increased the odds of a 50-basis-point boost in the Fed Funds rate at the upcoming FOMC meeting.

However, stock prices rebounded on Thursday, despite bond yields moving higher still, with dovish comments from Atlanta Fed Governor Raphael Bostic suggesting that he thinks the Fed can keep interest rate hikes to 25 basis points the catalyst.

Stocks and bonds both staged a big rally on Friday, even as data on the health of the crucial services sectors came in better than forecast, suggesting the economy might be in better shape than thought…which should have increased the chance of a more hawkish Federal Reserve.

THE NUMBERS DON’T LIE

We always endeavor to go beyond the headlines and challenge the conventional wisdom by analyzing the historical evidence. Our investment newsletter, The Prudent Speculator, recently published a Special Report looking at how stocks have performed when interest rates are rising and falling.

The Prudent SpeculatorConsider Cheering Higher Rates – The Prudent Speculator

A rising rate environment heightens concern that risk assets, including stocks, will decline in price due to the higher cost of capital. In actuality, our analyses show that equities historically have been indifferent to rising interest rates. Strange as it sounds, more than five decades of historical market data demonstrates that Value investors benefit handsomely from higher interest rates.

We think the excess return method displayed above enhances the analysis because the comparison removes the bias that comes with the actual level of rates. Sure, it’s easy to argue that this time is different (every environment is different) but we have also sliced and diced the historical returns numbers in other ways.

About the only thing we can with any certainty is that rising long-term interest rates are bad for…long-term bonds.

Market history also suggests the present level of rates should not be particularly concerning to investors either, even if it’s a bit shocking to see mortgage or other debt rates soaring from extremely low levels. Rising rate environments are a normal market phenomena and should not deter investors from staying the course. The stock market always seems to be on the edge of a precipice, yet we refuse to let near-term worries weaken the enthusiasm we have for the long-term prospects of our Value-oriented, broadly diversified portfolios.

BUCKINGHAM BUY

Continuing to put my money where my mouth is, despite the Wall of Worry that we now face, I will be adding more shares of MedtronicMDT
to my own portfolio on Monday. Medtronic is a medical technology company that develops, manufactures and markets medical devices and technologies to hospitals, physicians, clinics and patients.

Shares ran counter to the overall sector in 2022, losing a quarter of their value vs. a 4% dip for the S&P 500 Health Care Index, but headwinds like chip-related supply-chain issues and COVID-affected procedure volumes appear to be fading. Medtronic turned in a reasonable fiscal Q3 financial report, earning $1.30 per share (vs. $1.27 est.), with strong results in the cardiac rhythm and heart failure, neuromodulation and structural heart categories.

Following recalls with previous models, MDT has struggled to gain FDA approval for its latest insulin pump despite broad adoption outside the U.S. (18% growth in the latest quarter). So, I remain patient, given the company’s historical record (and some recent hurdles being outside of its control). Medtronic historically has held roughly 50% market share in its core heart device business and is a leader in spinal products, insulin pumps and neuromodulators for chronic pain. I think highly of its products for acute procedures and pipeline for a variety of chronic diseases.

High-quality MDT trades with a NTM P/E ratio of 15.5, well below the historical norm. The yield is 3.3%.