How Rising Interest Rates Affect Stocks and Market Leadership
Market Commentary
How Rising Interest Rates Affect Stocks and Market Leadership
How rising interest rates affect stocks has become an important question as higher Treasury yields contribute to changing performance across U.S. large-cap, international, and small-cap equities.
In the latest Market Commentary, Rick Wedell, Chief Investment Officer of RFG Advisory, explains how movements in interest rates can influence stock valuations, currency markets, and investment performance.
At the time of recording, the S&P 500 was near 7,800 and up approximately 15% year to date. However, beneath those headline numbers, there has been a meaningful shift in market leadership.
Over the previous 30 days, the S&P 500 had gained approximately 2%. During that same period, international equities, represented by the ACWI ex-U.S., declined approximately 2.4%, while U.S. small-cap equities declined approximately 3.8%.
That represents a significant reversal from earlier in the year, when international, small-cap, and mid-cap equities had been outperforming U.S. large-cap stocks.
One of the primary drivers behind the recent change has been interest rates.
The 10-year U.S. Treasury yield had recently risen to approximately 5.2% at the time of recording. Higher U.S. interest rates can affect different areas of the financial markets in different ways.
For international equities, higher U.S. rates can contribute to a stronger U.S. dollar as investors respond to changing yields and relative investment opportunities.
Over roughly the same one-month period, the U.S. Dollar Index increased approximately 3.5%.
Currency movements matter because international investments held by U.S. investors are affected by changes in exchange rates. When the dollar strengthens, returns from foreign investments can be reduced when translated back into U.S. dollars.
According to Rick, nearly all of the recent performance difference between domestic and international stocks during this period could be attributed to exchange-rate movements rather than significant differences in the underlying performance of U.S. and international companies.
Higher interest rates can also create challenges for small-cap stocks, particularly growth-oriented companies.
Investors often value growth companies based on the cash flows those businesses are expected to generate several years into the future.
When interest rates rise, the discount rate applied to those future cash flows also increases. This can reduce the present value investors assign to a company’s expected future earnings.
At the same time, investors can earn higher yields from relatively more stable alternatives.
Together, these factors can make investments dependent on future growth less attractive, helping explain some of the recent underperformance in small-cap growth stocks.
The recent market shift illustrates how quickly changes in interest rates can influence different areas of the equity market.
Looking ahead, investors are turning their attention to third-quarter earnings season.
Financial companies will be among the first to report, providing an early indication of how corporate earnings are developing. Expectations remain elevated following strong results during the first two quarters of the year.
Inflation will also be an important focus.
Upcoming Consumer Price Index (CPI) and Producer Price Index (PPI) reports will provide additional information about price pressures across the economy.
At the time of recording, expectations were for inflation to remain relatively firm, but not necessarily strong enough to prompt the Federal Reserve to raise interest rates at its next meeting.
However, subsequent Federal Reserve meetings could remain in play depending on how inflation develops.
For investors, the recent market shift is another reminder that diversification is dynamic. Different asset classes do not always move together, and relationships between investments can change quickly as interest rates, currencies, earnings expectations, and economic data evolve.
Understanding how rising interest rates affect stocks can help investors maintain perspective as market leadership changes.
KEY TAKEAWAYS: HOW RISING INTEREST RATES AFFECT STOCKS
S&P 500 remains strong: The index was near 7,800 and up approximately 15% year to date at the time of recording.
Market leadership has shifted: Over the previous month, the S&P 500 gained approximately 2%, while international stocks declined 2.4% and U.S. small caps declined 3.8%.
Higher rates are influencing market performance: The 10-year Treasury yield had risen to approximately 5.2%, contributing to changing relative performance across asset classes.
A stronger dollar is weighing on international returns: The U.S. Dollar Index gained approximately 3.5% over the same period, creating currency-related pressure on international investments.
Small-cap growth stocks are sensitive to higher rates: Higher discount rates can reduce the present value of future cash flows, while higher-yielding alternatives become more attractive.
Earnings and inflation are next: Third-quarter earnings, CPI, and PPI reports will help shape expectations for future Federal Reserve policy.
RFG Advisory empowers independent financial advisors with the technology, investment solutions, and dedicated support they need to build and grow their businesses while maintaining their independence.
How Rising Interest Rates Affect Stocks and Market Leadership
How Rising Interest Rates Affect Stocks and Market Leadership
How rising interest rates affect stocks has become an important question as higher Treasury yields contribute to changing performance across U.S. large-cap, international, and small-cap equities.
In the latest Market Commentary, Rick Wedell, Chief Investment Officer of RFG Advisory, explains how movements in interest rates can influence stock valuations, currency markets, and investment performance.
At the time of recording, the S&P 500 was near 7,800 and up approximately 15% year to date. However, beneath those headline numbers, there has been a meaningful shift in market leadership.
Over the previous 30 days, the S&P 500 had gained approximately 2%. During that same period, international equities, represented by the ACWI ex-U.S., declined approximately 2.4%, while U.S. small-cap equities declined approximately 3.8%.
That represents a significant reversal from earlier in the year, when international, small-cap, and mid-cap equities had been outperforming U.S. large-cap stocks.
One of the primary drivers behind the recent change has been interest rates.
The 10-year U.S. Treasury yield had recently risen to approximately 5.2% at the time of recording. Higher U.S. interest rates can affect different areas of the financial markets in different ways.
For international equities, higher U.S. rates can contribute to a stronger U.S. dollar as investors respond to changing yields and relative investment opportunities.
Over roughly the same one-month period, the U.S. Dollar Index increased approximately 3.5%.
Currency movements matter because international investments held by U.S. investors are affected by changes in exchange rates. When the dollar strengthens, returns from foreign investments can be reduced when translated back into U.S. dollars.
According to Rick, nearly all of the recent performance difference between domestic and international stocks during this period could be attributed to exchange-rate movements rather than significant differences in the underlying performance of U.S. and international companies.
Higher interest rates can also create challenges for small-cap stocks, particularly growth-oriented companies.
Investors often value growth companies based on the cash flows those businesses are expected to generate several years into the future.
When interest rates rise, the discount rate applied to those future cash flows also increases. This can reduce the present value investors assign to a company’s expected future earnings.
At the same time, investors can earn higher yields from relatively more stable alternatives.
Together, these factors can make investments dependent on future growth less attractive, helping explain some of the recent underperformance in small-cap growth stocks.
The recent market shift illustrates how quickly changes in interest rates can influence different areas of the equity market.
Looking ahead, investors are turning their attention to third-quarter earnings season.
Financial companies will be among the first to report, providing an early indication of how corporate earnings are developing. Expectations remain elevated following strong results during the first two quarters of the year.
Inflation will also be an important focus.
Upcoming Consumer Price Index (CPI) and Producer Price Index (PPI) reports will provide additional information about price pressures across the economy.
At the time of recording, expectations were for inflation to remain relatively firm, but not necessarily strong enough to prompt the Federal Reserve to raise interest rates at its next meeting.
However, subsequent Federal Reserve meetings could remain in play depending on how inflation develops.
For investors, the recent market shift is another reminder that diversification is dynamic. Different asset classes do not always move together, and relationships between investments can change quickly as interest rates, currencies, earnings expectations, and economic data evolve.
Understanding how rising interest rates affect stocks can help investors maintain perspective as market leadership changes.
KEY TAKEAWAYS: HOW RISING INTEREST RATES AFFECT STOCKS
RFG Advisory empowers independent financial advisors with the technology, investment solutions, and dedicated support they need to build and grow their businesses while maintaining their independence.
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