Are Higher Rates Bad for Stocks?

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Stocks rally even as rates rise. Forget Europe: markets now move on interest rates and oil.

Have you noticed? The ISDA held the first of the two-part auction to settle the credit default swaps (CDSs) on Greek debt, and...no one noticed. It did not move the markets. At all.

My point: Europe has calmed down; it is not moving global equity markets any longer.

I didn't say it would NEVER move the markets again; I said it is no longer moving markets now.

Look at today: stocks are AGAIN moving up, even as 10-year yields are moving up — higher yields are NOT an impediment to stocks (yields on the 10-year Treasury have gone from 2.029 percent a little over a week ago to 2.32 percent today) — at least not yet.

Are higher yields inevitably bad for stocks? Listening to some, you'd think that the Fed "turning the spigot off" will be the end of stocks.

That's not necessarily true: if growth expectations are expanding, there is no reason this will be a headwind for stocks. That's why you should look for upward revisions to GDP index. If you get that, it's a sign that stocks will be fine with higher rates.

If the Fed can keep the short end of the yield curve lower, while letting some of the longer rates moving up? A steeper yield curve is usually constructive for stocks, particularly banks.

We can see this in the collapse of the "spot" price in the CBOE Volatility Index (VIX), now down 14 or so from 20 a few weeks ago.

We’re not out of the woods yet: volatility worries have not gone away, it has merely been transferred from Europe to interest rates and oil.

If concerns over a "hot" war between Iran and Israel diminish, oil will certainly come down (I have heard there could be as much as a $20 "risk premium" in oil due to Iran worries), and stocks can rise even more.

But for the moment, oil and interest rates have some investors cautious. That's why if you look out just a few months, you'll see VIX Futures much higher: nearly 24 in May, nearly 27 in August. Lots of issues around the Fed potentially ending its Operation Twist at the end of June, the French elections in April, and the U.S. elections further out.

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