Thursday, March 30, 2006

Interest Rates Up; Financial Stocks Down

In the last four trading sessions, interest rates on the 10-year note ($TNX) have risen by about 3.85%, while financial stocks ($BKX) have been down -1.65%. What happens after we have such rising rates and weakening financial issues?

I went back to January, 2003 (N = 813) and found 99 occasions in which interest rates had risen by 3% or more in a four-day period. Four days later, interest rates rose on average another .58% (55 up, 44 down). When interest rates were up by 3% and $BKX was down more than 1% over the four-day period (N = 25), rates rose over the next four days by an average .71% (16 up, 9 down).

Interestingly, this pattern appears to have changed over the course of the lookback period. When I examined the most recent data in which interest rates were up and $BKX was down (N = 13), the next four-day rise in rates was only .12%, but the next four day change in SPY was down -.20% (6 up, 7 down). This is weaker than the average four-day gain in SPY of .18% (457 up, 356 down).

When I looked at the data in 2003 and early 2004 (N = 12), the next four-day rise in rates was 1.36%, but the average four-day change in SPY was .42% (7 up, 5 down). Early in the bull market, rate rises led to greater rate rises, but also led to stock strength. More recently, rate rises have not led to greater rate rises, but have led to stock underperformance in the near term.

Whereas stocks held their ground during interest rate rises early in the bull market, they now display subnormal returns. That appears to be particularly the case among financial and large cap issues.