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Tuning Out the Noise

When Rates Go Up, Do Stocks Go Down?


Should stock investors worry about changes in interest rates?

Recent research performed by Dimensional Fund Advisors helps provide insight into this question.[1]   This research shows that, like stock prices, changes in interest rates and bond prices are largely unpredictable.[2] It follows that an investment strategy based upon attempting to exploit these sorts of changes isn’t likely to be a fruitful endeavor.

Unlike bond prices, which tend to go down when yields go up, stock prices might rise or fall with changes in interest rates. To address the initial question: when rates go up, do stock prices go down? The answer the research shows is yes, but only about 40% of the time. In the remaining 60% of months, stock returns were positive. This split between positive and negative returns was about the same when examining all months, not just those in which rates went up. In other words, there is not a clear link between stock returns and interest rate changes.

This video summarizes the data found in this study:
 

 


Conclusion

There’s no evidence that investors can reliably predict changes in interest rates. Even with perfect knowledge of what will happen with future interest rate changes, this information provides little guidance about subsequent stock returns. Instead, staying invested and avoiding the temptation to make changes based on short-term predictions may increase the likelihood of consistently capturing what the stock market has to offer.

 

 

 

[1]. Wei Dai, “Interest Rates and Equity Returns” (Dimensional Fund Advisors, April 2017).

[2]. See, for example, Fama 1976, Fama 1984, Fama and Bliss 1987, Campbell and Shiller 1991, and Duffee 2002.