Investors reading their financial news publications of choice over the last year or so may have come across a headline titled something like “How Higher Interest Rates Will Affect the Stock Markets”. These articles typically go on to talk about how higher interest rates lead to higher borrowing costs for companies, which lead to lower profits/valuations and in turn poor equity performance.
However, historical data suggests this is not necessarily the case. Exhibit 1 below plots monthly returns of the US equity risk premium on the vertical axis against monthly returns of the 10-Year US Treasury Yield on the horizontal axis. As illustrated, we don’t observe a discernable relationship between higher bond yields leading to lower equity returns.