“Study the past if you would devine the future.” — Confucius
The past may not be a prologue, but it can be relevant. What does history have to tell us about stock leadership as interest rates rise?
We looked at rising interest rates from June 30, 1953 through June 30, 2013, which is 60 years (or 240 quarters), ending with former Fed chair Bernanke’s taper tantrum event. Over 30% of these quarters — 77 quarters specifically — were rising rate periods, defined as at least a ¼-point up move in the 10-year treasury yield. As an FYI, falling rates occurred in 69 quarters and stable rates accounted for the remainder of the quarters.
Since most Fed followers, including ourselves, believe rates are headed higher, we focused on several factors to examine what this 60-year period told us. There were some key patterns in both rising and falling rate periods. Given the outlook for rising rates, we looked at how cyclical sectors performed versus defensive sectors. Given the economy is doing well enough for the Fed to raise rates, the sectors tilted toward a cyclical bias did do the best — and by a significant amount — as shown in the chart. For example, consumer durables provided a +10% annualized return over the rising rate periods, and several other cyclical sectors rose 4 to 6%. In contrast, the defensive sectors like Utilities and Telecom had returns of less than 2%.
In addition to this sector analysis, rising interest rates also favored lower dividend paying stocks, smaller companies and higher beta portfolios. Of course, falling rates tended to show the reverse.
We are big believers in diversification and would advise such to investors across each of these factors, but we also recognize some tilting to factors could be worth a look, such as sector, beta, capitalization yield, etc., that may get a tailwind from an improving economy.