Publication Categories: Articles Webinars Whitepapers FAQ Info

The Good and The Bad of Rising Interest Rates

By Justin McNichols, CFA
Print Version

Since bottoming at a close of 0.54% on March 9, 2020, the 10-year US Treasury yield has slowly and quietly risen nearly 70% to 0.89% as of this writing. With the Fed holding short-term lending rates in the 0-.25% range, the slope of the yield curve has steepened dramatically as seen in the chart below. Many believed longer-term interest rates would rise off of the historical lows set during the panic at the start of the pandemic. However, the question now becomes, how far will longer-term interest rates rise?

Rising longer-term rates indicate credit markets are expecting an increase in economic activity as the economy recovers from the pandemic-induced shutdowns and disruptions. The magnitude of the move is a positive sign indicating the economy is likely to experience high economic growth. Along with this, bond investors are anticipating a corresponding increase in inflation – which is a positive given how anemic inflation has been over the past decade.

On the flip side, rising longer-term rates are inevitably negative for equity valuations. In essence, bonds are competing with equities for a finite amount of investor capital. Increasing bond yields may put a cap on equity valuations. Essentially, as the equity risk premium (the amount of earnings yield that investors demand over Treasury yields) increases, it’s difficult for equity valuations to continue to expand. All else being equal, as interest rates rise, the P/E on equities falls. We will cover this in considerably more detail in our First Quarter 2021 Wealth Report, but this is a trend that may cap equity valuations in 2021.

Justin McNichols, CFA

Justin McNichols, CFA

Justin is the Chief Investment Officer for OPCM, and has over 25 years of experience. Justin is a member of the OPCM Investment Management Team, and became a principal of the firm in 2000. Justin is a member of CFA Society San Francisco and CFA Institute. Justin received a Bachelor of Arts degree in Economics in three years and a M.B.A. in Finance from the University of California at Irvine. Additionally, he is a CFA Charterholder.
The opinions expressed herein are strictly those of Osborne Partners Capital Management, LLC ("OPCM") as of the date of the material and is subject to change. None of the data presented herein constitutes a recommendation or solicitation to invest in any particular investment strategy and should not be relied upon in making an investment decision. There is no guarantee that the investment strategies presented herein will work under all market conditions and investors should evaluate their ability to invest for the long-term. Each investor should select asset classes for investment based on his/her own goals, time horizon and risk tolerance. The information contained in this report is for informational purposes only and should not be deemed investment advice. Although information has been obtained from and is based upon sources OPCM believes to be reliable, we do not guarantee its accuracy and the information may be incomplete or condensed. Past performance is not indicative of future results. Inherent in any investment is the possibility of loss.