How do Interest Rates REALLY Affect Bull/Bear Markets
Updated
Late 2022 / Early 2023 the idea that rising interest rates would mean declines in equities was widely accepted. This was the keystone point of many bear cases. Moreover, the Fed pivoting was the prominent bull thesis. As it turned out, both interest rates and equities went higher for longer.
And this is not actually a surprise, based on the back testing of interest rates as a signal. Rising interest rates is not a bearish signal when historically back tested. The very best outcome for that is random and it's fair to say it even implied the opposite. Rising rates correlates with rising markets.
Let me put it another way. If you didn't know about interest rates and the theory as to why low rates mean up and high mean down and you just looked at rate trends and equities trends, you'd probably end up thinking "Interest rate" referred to the rate at which people were "Interested" in buying stocks. High interest, boom. Low interest, bust.
In the original chart here are the interest rate decisions heading into the 2008 crash. From the start of rate hikes to the end of them the market gained 40%. When rates started to be cut was when the bear market began. Rates would drop from over 5% to 0.25% and then stay there. None of the time rates dropped was bullish.
Here's the interest rate chart from the time.
Equities over the same time.
The word for that is "Correlated".
It can be easy to prove any point using just one instance of all the available market moves in history so let's see if this correlation sticks if we test it against some other moves.
Let's do the two hyper bubbles of our time. The .Com bubble and the Nikkei bubble.
Japan 1980s - 1990.
The Nikkei made a high in 1990. Extremely recently, it returned to that high. 34 years later.
There have been many studies on the Japan bubble of the 1980's and the general consensus is the exceptional gains in the market were due to the BoJ's policies. It was a bubble fuelled by cheap money being pushed into the economy. After the bust this would be forever on referred to as the "Bubble economy". But before that everyone was really impressed.
In the 80's Japan's market was the best. It was the place to be. Through the 80's the Nikkei roared upwards. Into the end of 1989 it looked unstoppable - but it'd soon be stopped.
From 1990, the bear market began.
In the final year of the bubble a 30% gain was made.
This was during a period of aggressive rate hikes. The equities market topped along with rates and then they both crashed.
Nasdaq 1993 - 2000.
Rate hikes on would start in 1993 and they would continue until 2000 (With a brief easing in the middle).
During this time the Nasdaq gained over 1,000%.
As with all the other examples, what would end up happening is both interest rates and equities would top at the same time and during the reduction of rates the market would be crashing.
In all of these cases the following things happened:
In modern times, interest rates bottomed in 2021. From fractions of a percent we're now up to 5.5%.
While this has been happening many have said markets can not rally on these interest rates, but they always have. What is becoming interesting now is they've usually topped out with interest rates somewhere between 5.5% and 6.5%. The market top wasn't made when rates were cut but when they were held steady.
Markets are always full of ironies and one of the great ones now is there's a growing case of bull enthusiasm that rates are close to a top. Equities have survived the storm. Rates are soon going to go into a cutting cycle and markets can flourish on low interest rates. But the historical bias would be exactly the opposite.
The fact equities have rallied alongside rates has historically been a warning that there will be a correlation in the rapid reduction of interest rates alongside crashing markets.
We are now into a period where historical interest rates/equities trends would imply it's more worth looking at interest rates for bearish signals.
The historical signals would be hikes levelling off and then starting to drop. Perhaps with equities leading the drop.
And this is not actually a surprise, based on the back testing of interest rates as a signal. Rising interest rates is not a bearish signal when historically back tested. The very best outcome for that is random and it's fair to say it even implied the opposite. Rising rates correlates with rising markets.
Let me put it another way. If you didn't know about interest rates and the theory as to why low rates mean up and high mean down and you just looked at rate trends and equities trends, you'd probably end up thinking "Interest rate" referred to the rate at which people were "Interested" in buying stocks. High interest, boom. Low interest, bust.
In the original chart here are the interest rate decisions heading into the 2008 crash. From the start of rate hikes to the end of them the market gained 40%. When rates started to be cut was when the bear market began. Rates would drop from over 5% to 0.25% and then stay there. None of the time rates dropped was bullish.
Here's the interest rate chart from the time.
Equities over the same time.
The word for that is "Correlated".
It can be easy to prove any point using just one instance of all the available market moves in history so let's see if this correlation sticks if we test it against some other moves.
Let's do the two hyper bubbles of our time. The .Com bubble and the Nikkei bubble.
Japan 1980s - 1990.
The Nikkei made a high in 1990. Extremely recently, it returned to that high. 34 years later.
There have been many studies on the Japan bubble of the 1980's and the general consensus is the exceptional gains in the market were due to the BoJ's policies. It was a bubble fuelled by cheap money being pushed into the economy. After the bust this would be forever on referred to as the "Bubble economy". But before that everyone was really impressed.
In the 80's Japan's market was the best. It was the place to be. Through the 80's the Nikkei roared upwards. Into the end of 1989 it looked unstoppable - but it'd soon be stopped.
From 1990, the bear market began.
In the final year of the bubble a 30% gain was made.
This was during a period of aggressive rate hikes. The equities market topped along with rates and then they both crashed.
Nasdaq 1993 - 2000.
Rate hikes on would start in 1993 and they would continue until 2000 (With a brief easing in the middle).
During this time the Nasdaq gained over 1,000%.
As with all the other examples, what would end up happening is both interest rates and equities would top at the same time and during the reduction of rates the market would be crashing.
In all of these cases the following things happened:
- Equites began more aggressively up trending when hike cycles began.
- Equites would uptrend while rates also up trended.
- When rates levelled off, a high in equites was made.
- Equites were in a sell off when rates were reduced.
- Equites entered their weakest phase while rates were dropping.
- When the drops in interest rates were finished, equities bottomed.
In modern times, interest rates bottomed in 2021. From fractions of a percent we're now up to 5.5%.
While this has been happening many have said markets can not rally on these interest rates, but they always have. What is becoming interesting now is they've usually topped out with interest rates somewhere between 5.5% and 6.5%. The market top wasn't made when rates were cut but when they were held steady.
Markets are always full of ironies and one of the great ones now is there's a growing case of bull enthusiasm that rates are close to a top. Equities have survived the storm. Rates are soon going to go into a cutting cycle and markets can flourish on low interest rates. But the historical bias would be exactly the opposite.
The fact equities have rallied alongside rates has historically been a warning that there will be a correlation in the rapid reduction of interest rates alongside crashing markets.
We are now into a period where historical interest rates/equities trends would imply it's more worth looking at interest rates for bearish signals.
The historical signals would be hikes levelling off and then starting to drop. Perhaps with equities leading the drop.
Note
FED holds rates steady and forecasts 3 rate cuts this year. These are the exact conditions of interest rate based crashes historically mentioned in this post.
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