Will Stocks Go Down if Interest Rates Go Up?

By: Vern Sumnicht, MBA, CFP

The ten-year Treasury bond interest rates have recently moved up above 2.5% (October-November,
2013). Many investors are concerned that when the Federal Reserve stops printing money, interest
rates will go higher and their stock portfolios will go lower. Fortunately, there is some historical
precedent that might provide some insight into how the stock market might do in a rising interest rate
environment.
Back in the 1950s, much like today, the Federal Reserve was printing money and using it to buy
Treasury bonds in an effort to keep interest rates artificially low. As the Fed began to taper off on
printing new money, interest rates started to rise. Interest rates ran up from 2.5% in 1955 to almost
6% in 1968 (see the graph below).

What happened to the stock market during this period of rising interest rates? The stock market
soared (see graph below) this was one of the best historical periods the stock market ever
experienced.

Summary
History teaches that the last time interest rates on the ten-year Treasury bonds went up from 2.5% to
6%, the stock market went up 300%.
Today (late 2013), investors are also concerned when the media reports that the stock market is at an
all-time high. Does this mean stocks are overvalued? Again, history can help shed some light on
current market values. Much like today (2013), the stock market was at an all-time high in 1954 as
well. However, a less sensational and more appropriate way to describe the level of the stock market
in 1954 would be: after the stock market crash in 1929, it took stocks 25 years, until late 1954, to
finally reach a new high. Even though stocks were at an all-time high in 1954 and interest rates on
ten-year Treasuries went up from 2.5% to 6% from 19541968, stocks went 300% higher.
Likewise, today investors might hear or read that the market is at an all-time high, but, actually, the
market is only back to where it was 13 years ago before it crashed in 2000 (see the S&P 500 Nominal
Prices graph below).
Another way to consider the stock markets historical price and value is to look at it after adjusting
for inflation (see the S&P 500 Real Price graph below). In real terms (inflation-adjusted terms), the
stock market wasnt at a new all-time high in 1954, and it isnt really at an all-time high today.

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S&P 500 Nominal Price

2000

2008

2013

The S&P 500 index price in 2013 has

recently recovered to approximately
where it was 13 years ago before the
market crashed in 2000.

2000

S&P 500 Real Price

2013
2008

1968

1929
1954

Current Real Price: 1,747.15 @ 4:35 pm EST, Thu Nov 7

Inflation adjusted, constant August 2013 dollars.
Sources: Standard & Poors and Robert Shiller and his book Irrational Exuberance for historic S&P 500 prices, and
historic CPIs.

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S&P 500 PE Ratio

Current S&P 500 PE Ratio: 19.47 @ 4:42 pm EST, Fri Nov 8

Price to earnings ratio based on trailing twelve month as reported earnings.
Current PE is estimated from latest reported earnings and current market price.
Source: Robert Shiller and his book Irrational Exuberance for historic S&P 500 PE Ratio.

S&P 500 PB Ratio

Current S&P 500 Price to Book Value: 2.61 +0.03 (1.34%) @ 4:42 pm EST, Fri Nov 8 Current price to book ratio is
estimated based on current market price and S&P 500 book value as of June 2013 the latest reported by S&P.
Source: Standard & Poors

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A final concern is that if the market collapsed in 2000, and again in 2008 after reaching the current
(11/2013) price level, is it logical to expect the market to go down a third time after reaching the
same level? No one knows the direction of the market with absolute certainty. Based on technical
analysis, there should be some resistance or difficulty moving and staying above this price level.
Despite some possible technical resistance, there is a significant difference in fundamental value of
the S&P 500 index between the two market corrections in 2000/2008 and the current (11/2013)
market value.
The price to earnings ratio (P/E) of the S&P 500 index was 45 in 2000 and 65 in 2008 versus a P/E
ratio of 19 in 2013 (see PE Ratio graph above). Another fundamental measure of value is price to
book value (P/B). The P/B ratio of the S&P 500 index was 5 in 2000 and 2 in 2008 versus 2.5
currently in late 2013 (see P/B Ratio graph above).
In an effort to make a comparison and better understand the relative value of the S&P 500 index in
the years 2000, 2008 and 2013, all of this fundamental data can be put into perspective by multiplying
the P/E ratio and the P/B ratio (see table below). The higher the product of these two S&P 500 index
price ratios, the more fundamentally overvalued the price of the index is at that time.
Year P/E
P/B
Total
2000 45 x
5
= 225
2
= 130
2008 65 x
2013 19 x 2.5 = 47.5

The fundamental price data indicates that in the year 2000, stock prices were highly overvalued;
arguably, prices were irrationally exuberant and the market collapsed. In 2008, prices were back to
the same level as 2000 and although fundamental values had improved, prices were still irrational and
the S&P 500 index fell 50%. In late 2013, prices are again back to where they were in 2000 and 2008
but, over the thirteen-year period from the year 2000, corporations have significantly improved their
earnings and balance sheets, which translate into stock prices that are currently much more
reasonably valued than they were in 2000 and in 2008.
Conclusion
I believe that over the next decade, stock prices could go much higher than most people believe.
History proves that despite rising interest rates, should the Fed begin to taper off the printing of
money and purchase of Treasury securities, stocks can go much higher from current levels. In
addition, market fundamentals indicate stock prices are reasonable and shouldnt inhibit the stock
market from moving higher.
******
Vern Sumnicht has 25 years experience as a successful financial planner and has been recognized for four consecutive
years by Worth Magazine as one of the Nations Top Wealth Advisors.
The opinions discussed herein are those of Sumnicht & Associates, LLC. This is neither an offer nor a solicitation to buy
and/or sell securities. The information provided in this material should not be considered as a recommendation to
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