We finished the 2006 trading year making 20-day highs in the interest rate on the 10-year Notes ($TNX). Have rising rates been affecting stock returns for traders? I decided to take a look by going back to 2004 (N = 729 trading days).
Since that time, we've had 103 occasions in which the rate on the 10-year Note has made 20-day highs. (Observe that this means the Note itself made 20-day price lows). When that has occurred, the S&P 500 Index (SPY) has averaged a gain over the next three weeks of only .07% (56 up, 47 down). Conversely, when the 10-year rates have not made new 20-day highs (N = 626), the next three weeks in SPY have averaged a gain of .54% (389 up, 237 down). It would appear that returns have been subnormal after rates have been rising.
The rate on the 10-year Note has only been above 5% for 67 trading days, and these were clustered during the period of April-July, 2006. Three weeks after these occasions, SPY averaged a decline of -.47% (25 up, 42 down). When rates have been below 4.1% (N = 118), however, the next three weeks in SPY have averaged a gain of .97% (76 up, 42 down). Could it be that the market interprets rates above 5% as potentially damaging to the economy and hence to stocks?
Finally, when 10-year rates have risen by more than 5% in a 20-day period (N = 126), the next three weeks in SPY have averaged a loss of -.20% (53 up, 73 down). When 10-year rates have dropped by more than 5% over the past 20 days (N = 79), the next three weeks in SPY have averaged a gain of .78% (50 up, 29 down). Large rises (declines) in rates appear to have been associated with subnormal (superior) returns in the near term.
Clearly, the recent equity index market has preferred low rates to high ones. The recent rise in rates is one factor that may subdue near-term returns.