Is there any meaningful relationship between high interest rates and stock returns? WES CRILL is the Senior Investment Director and Vice President of Dimensional Fund Advisors, an asset management firm that bases everything it does on peer-reviewed academic evidence.
He takes a look at what the research shows.
Some investors have asked if stocks make sense in a world where short-term US Treasuries are yielding north of 5.5%. These investors can take solace in the historical evidence, which suggests that interest rates have not been meaningful predictors of stock returns. In years with above-median interest rates since 1955, during which the average three-month Treasury yield was 6.7%, US stocks returned an average of 12.1%. This is slightly higher than the average return in below-median interest rate years (11.6%), although the averages are statistically indistinguishable from each other.
Plotting annual US stock returns vs. Treasury yields further emphasizes the lack of a meaningful relation between the two. The level of interest rates is of little help in predicting stock returns. This is perhaps unsurprising when you consider interest rates are one of many factors reflected in discount rates for future cash flows.
Exhibit 1: Annual US stock returns vs. beginning-of-year three-month US Treasury yields, 1955-2022
FOOTNOTES
1 “Daily Treasury Par Yield Curve Rates,” US Department of the Treasury.
2 The t-statistic for the difference in means is just 0.13. The t-statistic is a statistical quantity commonly used to test whether a sample average is reliably different from a specified value (e.g., zero). Researchers often cite an absolute t-statistic value of at least 2.0 as the threshold for statistical reliability.
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