Figure 13-3: Long-term interest-rate changes and the stock market
Because of the inverse relationship between interest rates and stocks’ price-earnings ratios, rising interest rates from 1960 to 1982 contributed to a compound annual appreciation of only 2.9% in the S&P 500 Index over this 22-year period. Conversely, falling interest rates from 1982 to 2003 were a major long-term stimulus to the stock market, helping produce compound annual growth in the S&P 500 of 10.5% over 21 years. Note that bear markets from 1960 to 1982, with rising interest rates, were more frequent and longer, whereas from 1982 to 2003, with falling interest rates, bear markets were less frequent and shorter in duration.
Current Comment: The 10-year Treasury rate declined to below 3%, a new record low, in mid 2009. 10-year rates have rebounded to 3.5%-4.0%, but are likely to stay depressed over the coming year. Looking beyond 2010, however, dramatic increases in money supply and in government borrowing currently being implemented by the Fed to combat the current financial crisis and economic downturn are very likely to result in a longer-term uptrend in interest rates. This is likely to create a difficult secular environment for stocks during the next decade.
