The recent divergence between equity prices and treasury yields has spooked investors who think lower rates are a sign of softer economic growth.
Yet periods of decoupling are more common than you may think.
Since 2000, the correlation between the S&P 500 and the U.S. 10-year treasury yield has sharply swung into negative territory eight times, said Brian Belski, chief investment strategist at BMO Capital Markets.
In five of those times, however, both stocks and bond yields were higher in the periods that followed due to better economic conditions.
As a result, Mr. Belski believes stocks are the better indicator during periods of decoupling.
“In addition, the recent drop in rates appears to be more technical in nature from our lens given that trends in important economic indicators
have improved significantly since the start of the year,” he told clients, highlighting the likely rebalancing of pension fund portfolios and potential covering of large short positions by bond investors .
The strategist also noted credit spreads and stocks prices have exhibited a much stronger correlation historically than interest rates and stock prices have. But credit spreads and stock prices have not shown a similar level of decoupling recently.
Mr. Belski believes this provides more evidence that investors shouldn’t be worried about the decline in interest rates.
Instead, he thinks they should be preparing for the eventual rise in nominal rates that typically come with a growing economy.
“And while conventional thinking is that rising interest rates are bad for stock market performance our work shows that stocks actually perform better than average when rates are rising for cyclical and not inflationary reasons (which we expect to be the case),” the strategist said.
“If anything, lower rates could be a net positive for stocks as it may justify further multiple expansion while continuing to provide long-term stimulus to the economy.”