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. 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%. Note that bear markets from 1960 to 1982, with rising interest rates, more frequent and longer, whereas from 1982 to 2003, with falling interest rates, they were less frequent and shorter in duration.
Current Comment: The further recent decline in the 10-year Treasury rate to a remarkable 2.42 should serve as stimulus for an intermediate-term recovery in stock prices.
Looking beyond 2010, however, the 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, which may create a difficult secular environment for stocks during the next decade.
