The Relationship Between the S&P 500 (INDEXSP) and Interest Rates

With everyone predicting that interest rates and bond yields would begin to rise, I started to wonder what correlation, if any, exists between the two. Is the "inevitable" rise in interest rates going to doom the stock market? Here's what I found.

The chart below shows a simple graph of S&P stock performance and yields on the 10-year Treasury bond. I used the 10 year Treasury because it is a benchmark rate, used among other things to set 30 year mortgage rates. It is neither as short term as the Fed Fund rate or the 1-5 year Treasury bills and notes or as long term as the 30 year Treasury.

Below, you can see what the graph looks like:

I then did a scatterplot of the data to see if we could visually detect any correlation. If we did, I was going to run a correlation analysis. Here's what that chart looks like:

Not exactly the poster child for a strong linear correlation as far as I can see. Now, I'm not an expert in statistics, so if anyone else has any insight, feel free to post it below.

Nevertheless, it does seem clear that starting in 1980, when 10-year yields peaked and began coming down, the market began its massive bull run. Returns on the S&P accelerated sharply, and then accelerated again starting in 1995. The stock market crashed twice since 1980 despite falling interest rates so we can see that rates don't seem to be the cause of burst bubbles and temporary stock market events.

The chart also seems to indicate that in periods of rising rates (1953-1981), the stock market stayed relatively subdued. Markets went up, the S&P climbined from 24.62 in April 1953 to 121.89 at the peak of rates in 1981, but not at the same rate.

So, does this offer any clues of what we can expect in a rising rate environment, should we get one? Not really. It shows that rising rates do not mean stocks will fall, the opposite also seems to be true. If you want to look at it really broadly, I guess you could draw a conclusion that if rates rise over the next 30 years we shouldn't expect the returns of the next 30 years to match the returns of the past 30.

The Japanese experience offers yet another clue. As I've written before, Japan runs a huge budget deficit but has seen rates drop. In that same period, even as rates have dropped the Nikkei has dropped along with it. More evidence that rates and equities are not tightly correlated.