Charts of the Week: The Fed's Cutting & Yields are.... Higher??

Most of the time the Fed cuts, 10-year yields come down as well. But higher long yields after a cut are much more common than you think. Over a 3-month period (ours hasn’t even been that long), it happens 45% of the time. Almost half - not exactly a historical oddity. It’s a little less common over a full year (we’ll see if we get there), happening about a third of the time. You might be tempted to think this is a headwind for equities; perhaps the market is “undoing” the cut. History shows the exact opposite. Looking back to 1962, the market has delivered better returns when long yields head higher after a Fed cut. How does that make any sense? Because the vast majority of the time that yields are higher (vast majority = 68%), growth is better too. And it’s growth, not rates, that is the decisive factor for the equity market: the delta in market returns when the OECD LEI is rising versus falling is much more definitive than when yields are higher or lower.

The math looks identical for earnings. And that’s the situation we find ourselves in – higher yields, but with better growth and better earnings.

Shown differently, if long yields do end higher a year from now, but earnings growth and the economy prove durable, looking back at history that’s been consistent with almost triple the average returns for the equity market. In fact, if earnings and economic growth prove durable, long yields historically fall only a third the amount as when they’re not. So, even if the long end isn’t higher a year from now, if our current situation persists, we shouldn’t expect it to fall all that much either. And that’s a good thing: Rates are more often a reflection of growth, not a deterrent to it.

From an investment perspective, a durable earnings and growth cycle bodes well for economically oriented sectors, with the most classically defensive sector of Utilities looking like the riskiest proposition.

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