US interest rates are rising after a long period of all-time lows. More broadly, this shift means that investments in low-risk products—such as bonds—are offering minimal returns and, as a result, are not in strong demand among investors. Typically, risk-averse investors don’t have many other options for their cash right now, other than to move it into riskier equities, which in turn drives the stock market higher. This model examines the relative performance of the US stock market in light of current interest rates. As of November 30, 2023, the US stock market is Fairly Valued relative to a normal interest rate environment.

Below is our composite chart, which reflects this model. It combines US Treasury interest rates relative to their historical average (shown in red) and the S&P 500 price relative to its own exponential trend line (shown in blue). For more details, read the information below to understand the inputs and limitations of this model.

There are two core reasons that stock markets and interest rates tend to move inversely with one another.

Lower Corporate Profits. As market interest rates rise, companies that need to borrow money to fund profitable projects will face higher interest payments. This increase in borrowing costs can reduce their profits, and in some cases, may even prevent them from moving forward with certain projects altogether. Since stock prices are a reflection of a company’s expected future profits, lower profits generally result in lower stock prices. On the other hand, when interest rates fall, companies can borrow at lower costs, which boosts their profits and drives greater economic output.

Less Demand for Equity. As market interest rates rise, investors can earn higher yields from debt instruments like bonds, making them more attractive compared to equities (stocks). This reduces the demand for stocks, which in turn lowers their prices. On the other hand, when interest rates are very low, investors looking for returns on their cash have fewer options, pushing them toward riskier assets like lower-quality bonds and stocks. This increased demand for these assets drives their prices higher.

There's much more to learn about the inverse relationship between stocks and bonds. Feel free to explore these resources for more insights.

In short, what we’re primarily focused on is this key question: Is the current market fairly valued when taking into account the prevailing interest rates? This consideration is crucial, as interest rates play a significant role in determining the attractiveness of stocks relative to other investments, like bonds.

The chart below illustrates the Ten-Year Treasury Bond rate over the past roughly 60 years, from 1962 to today. During the '70s and '80s, rates surged as a response to high inflation, but since then, they have generally followed a steady downward trend.

The average (arithmetic mean) of this rate over the entire period is 5.87%. We haven’t seen rates in that range for about 20 years, but history does indicate that a healthy economy tends to push rates back up to higher levels eventually. The word "eventually" here carries a lot of weight, and predicting future decisions by the Federal Reserve or changes in their policies is beyond the scope of this article—though you can always find more information with a quick Google search.

Here is the same chart as before, but now with the 5.87% average trend line added. The chart on the right, in blue, displays the S&P 500 (inflation-adjusted) over the same period, along with its corresponding trendline. [This data comes directly from our S&P 500 Model details, so for more information on the data and trendline, refer to that section.]

Rather than examining the raw values of these charts, we can consider each one in terms of its performance relative to its respective trend line. Are the values above or below their trends? In the two charts below, we map each chart based on the number of standard deviations it is above or below its respective trend line.

In the left chart, you can observe that the current 10-Year Treasury interest rate is 0.50 standard deviations below its normal level. On the right, you can see that the S&P 500 is currently 1.3 standard deviations above its trend line.

Typically, when interest rates are relatively high, stock prices tend to be relatively low. What’s particularly interesting is when interest rates and stock prices are both in the same phase (either both high or both low, relative to their respective trend lines). Since we’re already expressing the data in both charts as standard deviations above or below trend, we can simply sum the two charts together to identify where they might be out of sync.