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In markets, we often hear of these precise levels, beyond which everything is said to unravel. The so-called “breaking point.”
Their allure is undeniable. If such a point existed, one could fully prepare for it in advance, exiting unscathed before the stampede of the masses.
Over the past few years, the most popular “breaking points” have been related to interest rates.
Starting with the first Federal Reserve hike in December 2015, which was said to be the “breaking point” for the economy/bull market, the predictions have been unrelenting. Hardly a day goes by now without some pundit throwing out a level on the 10-Year Yield (3%, 3.5%, 4%, etc.) or Fed Funds Rate (2%, 2.5%, 3%, etc.) that is said to be the level.
Do these “levels” have any basis in fact? Let’s take a look…
The 10-Year Treasury Yield is currently at 3.2%. After subtracting inflation of 2.3%, the real yield stands at 0.9%. Are such figures of any value in predicting equity market tops? Not exactly.
The table below illustrates the starting 10-Year Yield (nominal and real) at each of the Bear Markets in the S&P 500 going back to 1929. What you’ll notice is a total lack of uniformity from one Bear Market to the next. In 1946-47, stocks declined 28% from a starting 10-Year yield of just 2.21%, while in 1980-82 stocks declined 28% from a starting 10-Year Yield of 12.72%. Real yields show a similarly wide dispersion, with Bear Markets beginning with extremely low/negative real yields (1948-49) as well as extremely high real yields (1932-33).
The average 10-Year yield at the start of a Bear Market (5.04%) is not meaningfully different than the average in all periods going back to 1929 (4.97%). Neither is the average real 10-Year Yield (2.44% at start of Bear Market vs. 1.86% in all periods).
Data Sources for all Charts/Tables Herein: Robert Shiller, FRED, Bloomberg.
What about the Fed Funds Rate?
Is there a magic level at which policy becomes “too restrictive” for markets? Again, not exactly. In 2011, stocks declined over 20% while the Fed was about as easy as it has ever been (0.2% nominal Fed Funds Rate, -3.4% real). Contrast this with July 1998, when the Fed was much more hawkish (+3.9% Real Fed Funds Rate) and stocks declined by roughly the same amount. The current Fed Funds Rate (2.19%) is still extremely low on a historical basis (4.90% average since 1954), but that fact should not serve as an all-clear to investors. A bear market can start at any time and at any level, regardless of Fed Policy.
That’s not to say that higher rates and more restrictive monetary policy does not act as an impediment to economic growth or stock market returns at times. It certainly does. But to suggest that there’s a precise level upon which this will necessarily happen is simply not how this game works.
When it comes to markets, there’s no such thing as a “breaking point.” The level at which investor appetite shifts from risk-seeking to risk-aversion changes each and every day. And it’s the culmination of a multitude of factors, only one of which is interest rates.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Charlie is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Charlie holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.
In 2017, Charlie was named the StockTwits Person of the Year. He has been named by Business Insider and MarketWatch as one of the top people to follow on Twitter and his work has been featured in Barron’s, Bloomberg, and the Wall Street Journal.
You can follow Charlie on twitter here.
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