The stock market suffered a severe setback at the outset of February. Numerous factors might have contributed to the mayhem but the overriding reason for the damage was fears of higher interest rates.

The stock market has an indelible link with interest rates. This is a problem, right now.

Lower interest rates push down borrowing costs for businesses and force investors into stocks since the alternatives like CDs and bonds pay such a low return. Generally, lower interest rates are desired by the bulls.

On the other hand, higher interest rates make it more expensive for businesses to borrow money. Costs to businesses rise.

Furthermore, higher interest rates provide an alternative to stocks as investors can become satisfied earning a risk-free rate of return in something like a money market fund. Usually, higher interest rates are a drag on the stock market and are better for the bears.

When our economy sputters and corporate earnings are the primary concern, the stock market will tolerate higher interest rates, particularly if higher rates come with an improving economy. The good economic news will push interest rates higher but investors can overlook higher interest rates, to a degree, for the prospects of an ignited economy.

This was the “Goldilocks” scenario that fed the bulls appetite for stocks until this month. Economic growth was steadily happening but not at a clip that was too fast to push interest rates too far. Stocks liked this condition.

When economic growth finally accelerates, higher interest rates will ultimately upset the stock market. That is exactly what happened during the frenzy this month. The new tax bill, an expanded government budget, and an infrastructure bill all stoked fears of rates rising much further. The attention turned to concerns about an overheating economy as higher rates are a by-product of an overheating economy.

As the trend of interest rates plays out, it is important to consider the delicate relationship between the stock market and interest rate levels. Below is a 30-year chart of the 10 year Treasury bond, which is the most widely followed proxy of interest rates.

The stock market sell-off accompanied the recent rise in rates on the 10 year Treasury Bond. As we move forward in the current quarter, it would be safe to assume that if interest rates broke above the top end of the channel at the right, more damage would be in store for the stock market.

On the other hand, if interest rates were to remain well-behaved in the current channel, we could see a market recovery towards the highs of late January.

Regardless of the outcome, we stand ready to make any necessary adjustments to client portfolios to preserve capital and also the gains we have made over the past two years.

Peregrine Asset Advisers ● 9755 SW Barnes Rd. Suite 295 ● Portland Oregon 97225
503.459.4651 ● 800.278.1420 ● www.peregrineaa.com