Debunking the Interest Rate Myth and What You Should Really Watch Out For

This year has been all about rising inflation and interest rates. The current stock market losses coincide with rising rates almost perfectly, but it seems like this is the exception and not the rule. I found historical data for 10-year treasury bonds going back to the early 60s, and I plotted those yields (red line) against the US stock market (black line on the top panel). It is pretty evident that, more often than not, the stock market goes up while rates are rising. Since the '60s, we had ten periods of rising rates, and the market suffered losses during only 1 of the ten occurrences. In another occurrence, it was flat (back in the '70s, see red arrows). In the other eight instances (80% of the time), the market increased alongside rising rates (albeit with higher volatility). So history would suggest that higher rates should not be feared. Given this historical evidence, if market participants choose to sell off shares because of higher interest rates, long-term investors should take advantage of that.

The key question is whether we are still in a secular bull market that has been running since 2009 or are witnessing the beginning of a new secular bear market that could last a decade or so. If we are still in the secular bull market and this is just a cyclical bear market within a longer-term uptrend, then this market weakness will prove to be one of the best buying opportunities since 2008. On the other hand, the start of a prolonged bear market would warrant a more active investment approach than traditional buy-and-hold investing due to the lack of sustained trend during secular bear markets.

The Three-Year Rate of Change is a very simple indicator. It measures a rolling three-year total market return and is expressed as a percentage. It rarely ever goes below zero, but when it does, it often coincides with secular bear markets. This simple indicator has correctly warned about secular bear markets of the 70s and 2000s. So far, it is well above zero, so the weight of evidence suggests that the secular bull market is still intact for now.

Historically November and December have been good for stocks, especially if the rest of the year has been bad. We still expect an end-of-year rally, so stock selling is not advisable now. However, we will be watching this Rate of Change indicator very carefully. We don't want to end up with a hockey stick on the basketball court.