In previous blog posts, we’ve talked about how interest rate trends affect stock prices. In general, we’ve found that rising rates tend to be bad for stocks and vice versa. But there are various lengths or maturities of interest rates. Some would argue that long-term rates more closely align with the cost of capital that companies face than short-term rates. So, for this week’s featured indicator, we look at this dynamic but in the context of just long-term interest rates.
Specifically, we focus on long-term Treasury note yields. The U.S. Treasury issues bonds with maturities of 10, 20, and 30 years. We use an average of all three as our proxy for long-term interest rates—shown as the orange line in the bottom clip of the chart.
The top clip of the chart shows the performance of the S&P 500 stock index going back to 1966. You probably notice the up and down arrows accompanying this green S&P 500 line. They represent buy and sell signals as determined by the long-term interest rate composite. When long-term rates fall by about 9% from a weekly peak, a buy signal is generated. But if long-term rates rise by roughly 12% from a weekly low, it produces a sell signal.
Historically, these reversal points have been pretty good profit signals. If you had followed the buy and sell signals generated by this indicator, you would have compounded your money at an average rate of 9.8% a year, on average, versus just buying and holding the S&P 500 index and getting 7.3% per year. It might not seem like a lot, but those extra 2.5 percentage points a year really add up over time.
Now, there are a lot of risks associated with just following one indicator and one indicator alone. The profit signals and the historical performance tells us that the indicator has value. But we find that the indicator is more useful when used in conjunction with other types of interest rate indicators. Diversification—as with most things in investing—is the key to success.
This is intended for informational purposes only and should not be used as the primary basis for an investment decision. Consult an advisor for your personal situation.
Indices mentioned are unmanaged, do not incur fees, and cannot be invested into directly.
Past performance does not guarantee future results.