The Independent Market Observer

Post-Election Bond Rates and the Stock Market

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Nov 22, 2016 4:25:42 PM

and tagged Investing

Leave a comment

bond yieldsThe other day, we talked about the bond market and the effects of the recent sharp increase in interest rates. Although the immediate impact was real, we concluded that the adjustment was more a return to normal than something worse. In other words, nothing to worry about.

What do higher yields mean for stocks?

Amid all the commentary on the recent surge in stocks, the possible effects of higher bond yields haven’t really come up. No harm, no foul seems to be the general take. And yet, in theory, higher rates should have the same kind of negative effects on stock values that they do on fixed income investments. After all, low rates are thought to be one of the pillars supporting lofty valuations. Even though the market is going up, we should be thinking ahead to what higher rates might mean.

The best way to try and understand the future is to take a look at the past. The following chart, from J.P. Morgan’s Guide to the Markets, shows the effects of interest rate movements on the stock market.

bond yields and stock market-1.jpg

It’s a complex chart, but the conclusions are clearly summarized: “When yields are below 5 percent, rising rates have historically been associated with rising stock prices.” In other words, with rates at low levels like they were (and still are), stocks have gone up when rates did. In fact, the lower the initial rates, the more likely stocks were to rise when rates did.

Mathematically, this makes no sense, but economically, it is perfectly reasonable. When rates are at very low levels, it is because the economy is troubled and growth is low. When rates start to rise, that means conditions are getting better, which is good for companies and stocks.

For proof of this, we need only look to the Federal Reserve’s actions over the past several years, keeping rates low when growth was slow and now planning to increase them as growth accelerates. At the company and stock market level, the positive effects of faster economic growth have more than offset the negative effects of higher rates.

Rates nowhere near the risk zone

That changes, of course, as the economy overheats and rates rise. At some point (around 5 percent in the chart above), higher rates become a drag rather than a boost as economic growth slows. Right now, we’re nowhere close to that level, but it is something to watch for. Even if you assume that threshold rate is now lower—and I can make a good argument that it is—we’re still not close. Rising interest rates may remain a positive signal for the stock market for some time.

Looking at it another way, since World War II, there have been 21 pops in long-term bond yields. In 13 of those instances, stock valuations rose, and in 18 of them, the S&P 500 appreciated. The situation right now is completely consistent with that data. In the three instances that the S&P 500 declined, the rise in rates was well above what we see now.

This looks to me like more good news

The rise in bond yields since the election seems to reflect expectations of faster growth, and thus far, the market is validating that. Given those conditions, it seems reasonable to conclude that the results of higher rates this time will mirror those of the past and continue to support stock valuations.

Unlike with fixed income, where higher rates have a short-term negative and a longer-term positive effect, higher rates are a positive signal for stock markets—and should remain so for some time to come.

Subscribe via Email

New call-to-action
Crash-Test Investing

Hot Topics

New Call-to-action



see all



The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.


Please review our Terms of Use

Commonwealth Financial Network®