See for yourself.
the start of 2022, 10-year US government yields, which I consider fairly representative of the broader mid-term bond market, have gone from nearly 1.60% at the start of the year to nearly 3.34 % at the time of this writing.
In my opinion, this is the main factor explaining the nearly 24% drop in the S&P 500 index from December 31, 2021, to its low on June 17. Indeed, on June 14, the 10-year US government rates had reached 3.48%, a peak since 2011. As I have previously written, a rise in interest rates directly affects the value of any financial asset.
But, in my opinion, this is also what explains why the markets rebounded strongly between mid-June and mid-August: the S&P 500 jumped almost 19% between its low on June 17 and August 16. During the period, the 10-year US government rates fell from 3.48% to around 2.60% (August 1).
And I bet that’s why markets have nose-dived again in the past few weeks: since August 1, US government 10-year rates have rebounded to 3.34%.
If you’re one of those people trying to predict what the stock markets will do between now and the end of the year, you might just have to predict what the US government’s 10-year interest rates will do. (Good luck!) That’s why so many observers focus their attention on whatever the Federal Reserve and its Chairman, Jerome Powell, say about interest rates.
But, in the long term?
Below is a chart that separates the performance of the S&P 500 index into three decades since 1990:
First of all, note that the decade 1990-2000 was exceptional, not only in terms of the performance of the index (299.8%, excluding dividends), but also in terms of the growth of the profits of the companies that make up the index (147.8%).
Second, notice how difficult the decade 2000-2010 was for the investor, with a return of -4.7% (again excluding dividends). I call it the “lost decade”. But what explains the poor performance of the index for the period is not so much the absence of earnings growth (49.2%), but more a decline in the valuation of the stock markets. You’ll notice that the price-earnings ratio was 15.0 at the end of 2009 compared to 23.5 at the end of 1999. And that’s despite the fact that interest rates came down during the period (from 5.1% to 3.3%)!
In my opinion, this table demonstrates that, over long periods, interest rates are only one of the components that influence stock market returns. The others, equally important, are: corporate earnings growth and general stock market valuation.
currently only have eyes for interest rates and the Fed’s message. In the long term, however, corporate earnings become much more important, as does the general valuation levels of stock markets. This is where long-term investors should focus their attention.
