NEW YORK (MainStreet) — The prices of equities are not always driven by interest rates, several experts said.
While it appears that an increase in interest rates would drive down stock prices, that scenario is not always true, said Craig Lazzara, global head of index investment strategy for S&P Dow Jones Indice, in a recent research blog post.
The past 15 years of returns for equities indicate the opposite, he said. Since 1998 when the 10-year Treasury rates declined, the average return on the S&P 500 was -0.38%, Lazzara wrote in the report. However, when the 10-year Treasury rose, the S&P 500 rose by an average of 1.81%, the report said.
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"This counterintuitive behavior suggests that interest rates were not driving stock prices, but rather that both rates and stock values were both being driving by exogenous factors," Lazzara said.
The Federal Open Market Committee chose to continue to purchase bonds at $85 billion each month in a meeting last week. This move surprised the financial markets, which had counted on a small adjustment to the past five years of a lax monetary policy. The FOMC could chose to limit the number of bonds it buys back in late October. Tapering the Fed's quantitative easing program would result in interest rates rising.
Rising interest rates do not always affect stocks negatively, said Fei Mei Chan, associate director of index investment strategy for S&P Dow Jones Indice.
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"It is not a sure thing that interest rates are bad for equities," she said. "It does have an impact on equity performance. We're sitting at a historical low in interest rates. It's not a matter of if interest rates will rise, but when they will increase. Everyone is anticipating the increase."
Between January 1991 and June 2013, the average monthly return for the S&P 500 was 0.85%, according to a report by Chan and Lazzara.
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"Paradoxically, in the three periods of rising rates, the average monthly return was 0.96%, compared to an average monthly return of 0.82% for the periods of declining rates," the report said. "Rising rates have clearly not been bad for stocks over the past two decades."
Even the possibility of tapering can result in interest rates rising, Chan said.
"The market has been bipolar," she said. "Keep in mind that aside from interest rates, many things go into equity performance."
When interest rates are low, investors focus more on equity performance instead of bond returns, said Aaron Izenstark, managing director of IRON Financial, based in Northbrook, Ill.
"It's a scale," he said. "Investors are going to weigh what they can get potentially."
Since interest rates are still so low, they would have to rise "significantly to affect anything," Izenstark said.
"When internet rates are really low, investors look at equities as a better investment because they are getting a dividend close to a Treasury yield," he said.
Treasury yields are a benchmark, because the securities are backed by the credit of the U.S. Treasury, lowering their risk level.
Investors should position their portfolios to have less in long-term bonds and focus on the potential for dividend growth instead of how high the yield is, said Kate Warne, investment strategist for Edward Jones.
"A better place for investors is to look for lower yields where companies will provide better dividend increases in the future," she said. "The companies that are already paying high yields are not likely to raise them. Dividends provide income over time."
Stocks thrive whether interest rates are rising or falling and the current environment is good for stocks, Warne said.
"Typically, stocks do well when interest rates rise or fall as long as interest rates are low," she said. "Investors should be buying stocks. This is an environment where we see continued modest economic and earnings growth. The economy is strong enough to support further stock increases. Most investors are a bit skittish of stocks and that is one sign they should be owning more of them."
--Written by Ellen Chang for MainStreet