Rising Treasury Yields: Why Higher Interest Rates Pressure Stocks

During their recent episode of the Acquirers Podcast, Travis and Carlisle discussed Rising Treasury Yields: Why Higher Interest Rates Pressure Stocks. Here’s an excerpt from the episode:

[Tobias] Yeah, I’m not sure what the reason is. I think one of the things that I think it’s probably caused by has been this massive ramp in the yield. So I track the 10-year yield because I think that that’s a proxy for stocks.

I don’t know whether it’s the really long data. I don’t know if anybody’s ever looking at the 30-year when they’re thinking about stocks, but I think the 10-year is a pretty good proxy. It’s gone through.

It was 5.26 yesterday at the close. I think it’s like 5.4 or something now. The yield is really ramping up.

The long run average is about 6%, I think. So I actually looked up a chart. I found one on the multiple.com website that goes back 150 years. And I looked at it in terms of how often has it been higher than this level. And so we have to go all the way back to April 2002 to see a 5.2 handle. We got close, I think, through 2007, but I think it topped out at about 5.1. So you’ve got to go back a long way. That’s 24 and a half years, almost 25 years since we’ve seen rates this high. And then we’ve only been higher than this through the 60s to the 90s, which is about 35 years out of that 150. So I think these are fairly unusual circumstances.

And probably the rate at which has gone up is even more unusual. And I think that that is what is impacting stocks. I know that Buffett has said that rates act like gravity on equity prices, which makes total sense to me that if you’ve got an alternative that’s risk-free, as risk-free as you can get versus something that’s whipping around like equity, then you might prefer to just take that risk-free 5.4 or whatever you can get in the market. But then there’s also this other study that I’ve seen on the equity risk premium. John Hussman has this great long-term study where he looked at how predictive is the equity risk premium. So the equity risk premium is the size of the yield, the size of the equity pre-E yield, so the E on the P rather than the P on the E, versus the yield on the 10-year.

And he’s basically found that there’s no connection between them whatsoever. And it’s really just the absolute level of equities that dictates the returns, which is totally unexpected to me. I don’t know why that result is, but that’s what the data shows.

So I’m sort of inclined to believe that, even though I can see how behaviour would be impacted by the level of rates. So I don’t know then, the next question is sort of what’s driving rates, but let me get your take on rates first.