Why the Stock Market’s Dive Was an Overreaction

As benchmark 10-year Treasury finally rises over 3.2%, equity investors fear growth-choking interest rates are en route.

So the stock market took a dive Thursday when the 10-year Treasury yield rose, huh? Come on. What do you expect when the economy is booming and inflation, however fitfully, is nudging up?

The dominant fear is that rising interest rates, which the 10-year note is a benchmark for, will choke off economic growth and the current equity bull run. So the S&P 500 fell 1% for the day, as the 10-year poked above 3.2% for the first time in seven years. The Treasury bond, except for a brief period earlier this year, finally rose above 3.0% on September 5.

The market dip came after Federal Reserve Chairman Jerome Powell said the central bank would keep pushing up short-term rates, perhaps more than the so-called “neutral level,” where rates neither help nor hurt growth. (Note: Neither he nor anyone else is sure where that is.) And then there is the added geopolitical worry stemming from the harsh rhetoric between the US and China as they sink deeper into a trade war.

All of this interest rate sturm und drung is an over-reaction, according to Jamie Cox, managing partner for Harris Financial Group. Some investors are surprised, he said, but the “reason yields are rising are positive, not negative. Yields need to be higher—the economy is booming and money velocity has picked up.”

Of course, the relationship between interest rates and stocks is relative. The big fear in corporate America is that companies will at some point have difficulty borrowing, which could stunt economic growth. But in the 1990s, the longest economic up-cycle in US history, the 10-year yield was between 8.25% and 6%, much higher than now. On the other hand, rates were trending down then, as they aren’t now.

Cox is among those who think that yields aren’t headed for the stratosphere, to say the least. “Yields are not going much higher,” he wrote in a note to clients, “so folks can calm down and stop with the hysteria about rates torpedoing the economy.”

What level of rates would constitute a clear and present danger? Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance, wrote that he thinks a 3.5% to 4% 10-year Treasury would result in a large stock market selloff.

But he also thinks rates will “find a new equilibrium closer to our current levels and not spike much higher in the near term.” And when that happens, he went on, “the attention of equity investors should return to corporate earnings and economic strength in the broader US economy.”

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