The depreciation of the Yuan against the US dollar by 3.4 percent last week caused by reform to the fixing method sent reverberations across commodity markets, revitalizing gold’s safe haven status
2015 could be the year we finally see rising interest rates in the U.S. This creates an opportunity to reassess portfolios and asset classes and evaluate how they performed during historical periods of rising interest rates. While the past can never guarantee the future, historical context is important for understanding a phenomenon that we really haven’t seen in a longer-term trend for approximately 30 years.
Bonds vs. Stocks
The critical question here—as in many environments—is stocks versus bonds. By design, the fixed nature of bond interest payments creates a bit of a headwind as rates rise. On the other hand, rising interest rates usually occur in tandem with rising inflation, and stocks have historically grown their dividends at a level above that of inflation over long periods.1
Big Picture: To the extent that rising interest rates reflect rising growth expectations and rising inflation expectations, we believe that equities can see a tailwind and perform quite well over the medium to long term, even if U.S. Federal Reserve (Fed) activity (or inactivity) can cause some short-term volatility.
Further Distinctions to Be Made
Also here – as in many environments – it’s not just stocks versus bonds, but types of stocks versus types of bonds.
Within equities, we wanted to look at three categories: large caps (the S&P 500 Index), small caps (the Russell 2000 Index) and high-yielding dividend payers (the Dow Jones U.S. Select Dividend Index). While this certainly doesn’t exhaust all equity possibilities, it does provide an interesting cross-section of a few major categories—indicating how they reacted in different periods of rising interest rates.
Within fixed income, we examined the difference between a pure government bond exposure (interest rate risk, but not credit risk), a high-quality bond index and a high-yield bond index (less interest rate risk, more credit risk). Within equities, we looked at dividend-paying stocks.
We’d expect higher-yielding dividend payers to face a headwind, while more growth-oriented companies could be better positioned to grow their dividends with rising interest rates and rising inflation.
We looked at times when the U.S. 10-Year Treasury note rose 100 basis points (bps) or more and saw the following:
- High-Quality and U.S. Government Fixed Income Faced a Headwind: Both the U.S. 10-Year Treasury note and the Barclays U.S. Aggregate Index experienced negative average returns during our rising rate periods.
- High-Yield Fixed Income Performed Better: While the BofA Merrill Lynch High Yield Index delivered differentiated performance with respect to the other two fixed income options, it was still able to generate a positive average return during the rising rate periods. It actually outperformed an index of high-yielding dividend payers on an average annual basis over these periods.
- Equities Strong to Quite Strong: Both the S&P 500 Index and the Russell 2000 Index tended to perform better during the rising rate periods than over the entire period. This fits with what we mentioned earlier—that equities can perform well when rising rates signal improvements in growth and generally rising inflation.
- Small Caps Were Especially Strong in Rising Rates: With the exception of the first rising rate period, from October 15, 1993, to November 7, 1994, the Russell 2000 Index delivered a double-digit return in every period. Its average annual return during the rising rate periods was 15.1%, versus its average annual return during the full period at 8.6%.
1 Source: Professor Robert Shiller, with data measured from 31/12/1957 to 30/06/2015 for the S&P 500 Index universe
Viktor Nossek - Director of Research - WisdomTree Europe
Interestingly gold remained resilient, seeing its price rise in US dollar terms for a second straight week, despite outflows from gold ETPs. The key to the commodity complex’s fortunes is China’s growth path and the market is on the lookout for further stimulus in the country
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