Critical points in financial markets are times when trends potentially change. And right now, interest rates are at a critical point.
Rates on 10-year Treasurys reached record lows in 2012 and 2016. Both times, sharp jumps in rates followed. In 2017, rates failed to reach a new low, but a sharp rally began anyway.
This chart shows the critical point. Higher rates change everything in the markets. But we don’t know if rates will continue to move up. They could fall, as they did before.
Ten-year rates above 3% would kill the bull market in stocks.
Higher rates provide income investors with an alternative to stocks. Much of the market’s recent gains resulted from the TINA environment. TINA stands for There Is No Alternative to stocks.
When investors earn inflation-beating income from bonds, an alternative to stocks exists. Higher rates will shift money from stocks. That’s one reason higher rates are bearish for stocks.
Higher interest rates also slow spending. New cars and new homes become more expensive, for example.
Even zero-interest furniture and appliances get more expensive. We all know financing charges are built into prices on zero-interest financing deals.
You see that sales of expensive consumer products slow if interest rates rise. So does business spending.
Many businesses finance operations with adjustable interest rate loans. Higher rates immediately hurt profits. Higher rates also reduce spending on new equipment.
That’s another reason higher rates hurt stocks. Lower profits for publicly traded companies make the stocks less valuable.
Now, we aren’t there yet. Rates are still low.
And they are following a familiar pattern: Sharp increases in rates raise expectations for even higher rates. But the last two times this happened, rates fell.
That’s the critical point for the market.
Traders will panic if rates rise any more. The Federal Reserve will view higher rates as a sign of inflation and raise rates even more. That will cause a recession.
But if rates fall like they did before, that will push money into stocks as TINA traders reappear.
Either way, there’s a big move coming. We’ll soon know which way the stock market is headed. And interest rates will be the guide.
Michael Carr, CMT
Editor, Peak Velocity Trader