Runaway Rates?

The 10-year US Treasury has hit a five-year high. Yikes! Five years is a long time! Rates are super high, and that must be bad for stocks. This is what investors could easily deduce from the tenor of recent headlines.

It's very true one important driver currently of our growing global economy and zippy stock markets has been cheap, easy money. And, we've written frequently at MarketMinder about the historically unique earnings yield-bond yield spread driving record levels of cash-based mergers—boosting earnings and reducing stock supply. ("If CEOs Don't, Investors Will Do It For Them" and "Smart, Smarter, Smartest.") If that gap closes, one major incentive for cash-based mergers dries up, and that might be a legitimate market concern, right? This recent article seems to confirm those fears:

An Era of Cheap Money - Gone
By Grace Wong, CNN Money
https://money.cnn.com/2007/06/14/markets/cheap_money_gone/index.htm?cnn=yes

The article shows a graph depicting recent rate moves. Rates look like they're going straight up—scary! But is this perspective right? A favorite trick of ours at MarketMinder is thinking about other times a similar event occurred and asking, "What happened after that?" Rates were about this high a year ago, and the market's nicely positive. Rates were this high five years ago, and then the market went on a tear. Rates were higher during both the 1980s and 1990s bull runs. Seems to us, nothing about this level of long-term interest rates automatically spells doom for stocks.

Here's another trick when you're encountered with scary headlines: Take a longer look at history. Headlines blare that interest rates are high—are they right? Look at the first graph below showing global long rates since 1982. Looks quite different from the graph in the aforementioned article, doesn't it? A cut of data from any short period can be very deceiving. Looking at a longer period, you see money is still relatively cheap.

Want more perspective? The second graph shows a far longer history of the 10-year Treasury. Fun, isn't it? Suddenly, you fathom that bond bulls longing for the days of 18% bond yields are seriously deluded. The ultra-high long rates of the 1970s and 1980s weren't normal, they were freakishly high. (Why is a story for another day, but big blame can be based on heinous monetary policy missteps globally, not likely to be repeated.)

Fact is, long rates of 5.2% aren't scary, unusual, or a harbinger of doom. And, even after recent rate moves, we still see about a 2% spread between global earnings yields and bond yields. The fundamentals driving the merger mania (and stock destruction) remain intact and stocks still look cheap relative to bonds—this bull's got room to run.