A Visual Presentation Of What Happens To The Market During Rising Interest Rate Cycles

Tyler Durden's picture

While it is no surprise that there is nothing in this world that can derail the optimism of Goldman's David Kostin (GS S&P 2011 target 1,500 until Jan Hatzius and his double Bill Dudley say otherwise), in his latest Weekly Kickstart he does provide a useful visual analysis of what happens in a period of rising interest rate cycles. Of course, this is only to create the illusion that rates are indeed set to rise: as we indicated said illusion was roughly two times stronger this time last year when the market once again didn't remember what a downtick looked like, and yet it all turned out to be a function of QE1, which upon ending on March 31 caused a correction, and QE2 a few months later. We wonder how many professional investors actually are naive enough to equate constant pumping of billions of dollars into the market by the Fed with economic improvement. But while we will get our answer in the next several weeks, here are the key signs to look for in the latter part of the interest rate cycle.

The first chart looks at what happens when rates are rising. What is stunning is that the last time we had the commencement of a real interest rate rise was back in 2004. And even that ended up to be far too late to make an impact. Not to mention that all such hikes were in a period of lower lows. Too bad we can't go much below zero (thank you ZIRP).

The next table looks at sector and general market returns X months into a tightening period. For those who buy that much can be gleaned from IR analysis during the great 30 year moderation, the best sector to buy would be IT and Materials.

Then again, since the IT sector return is massively skewed due to the 32% performance from the 1998 dot com bubble, perhaps it is best to avoid it...

The most useless chart of all is the expectation for the Fed Funds rate by Goldman and consensus. In a year we will all be laughing about this one.

Next, for those who care, here is Kostin's traditionally permabullish commentary:

The news flow during 1Q 2011 was anything but market-friendly. But a devastating and tragic earthquake and tsunami in Japan, political upheaval across the Middle East and North Africa (MENA), and absence of agreement on fiscal issues in Europe and the US could not shake the bull market.

S&P 500 rose 5.4% during 1Q and ended at 1326, in-line with our forecast. Our year-end 2011 target remains 1500 reflecting a potential prospective nine-month price gain of 13%. If achieved, the 2011 price return would be 19% and rank 0.6 standard deviations above the average annual return since 1928. Despite the resilient market, investors remain uneasy and list various macro and micro headwinds to further index advances.

Foremost among the concerns expressed by equity fund managers during our recent meetings is the risk of higher interest rates. Bears argue that $600 billion of planned Fed bond purchases under QE2, if they end as scheduled in June, will cause long-term interest rates to rise and spark a sell-off in US equities. Investors also fear rising US inflation data and forward-looking inflation expectations will prompt the Fed to raise shortterm interest rates before year-end. Our Global ECS Commodities research colleagues note the risk of substantially higher energy prices, upside risk to gold prices, and a tight inventory situation across the major grains, with soybeans and corn particularly susceptible to upside spikes. During the past week several regional Federal Reserve bank presidents publicly discussed policy tightening, stoking investor concern about how stocks will perform when the Fed eventually begins removing liquidity (see US Daily: Fedspeak – Sharpening the differences, March 29, 2011). Finally, the ECB is widely expected to hike interest rates on April 7th, which will also draw investors’ focus to the timing of the Fed’s exit.

However, Goldman Sachs US Economics forecasts Fed Funds will remain unchanged at 0%-25bp through 2011 (and likely 2012 as well) and ten-year interest rates will drift slightly higher from 3.5% currently to 3.75% by year-end 2011 and 4.25% by year-end 2012.

From a US portfolio strategy perspective we are interested in how domestic stocks might trade when interest rates begin to rise. We analyzed seven episodes of rising US interest rates since 1975 (see Exhibit 1). The timing of the interest rate increases was consistent across the maturity spectrum (Fed Funds, 2-year, and 10-year notes). The median return of the S&P 500 was positive during the 1-, 3-, 6-, and 12-month periods  after interest rates began to rise (see Exhibit 2).

Early stages of interest rate cycles typically favor cyclical equities. Since 1975 the first several months of a rising interest cycle have witnessed cyclical sectors outperforming defensives. In fact, the cyclical sectors of Information Technology, Materials, Consumer Discretionary, Industrials and Energy all outpaced the S&P 500 during the first three months of at least four and as many as six of the seven periods of rising interest rates since 1975. In contrast, Telecom, Utilities, Financials and Health Care beat the market on only a few occasions as rates began to rise. Note that Consumer Staples lagged the S&P 500 during the first three months of all  seven episodes (see Exhibit 3).

Information Technology has the best track record of outperforming the S&P 500 during the first one and three-month periods when interest rates begin to rise. Intuitively, the market interprets higher rates as evidence of stronger growth and rewards sectors such as Information technology that are most exposed to business expansion. Conversely, Utilities and Telecom consistently underperform the market during these periods. The yield-oriented aspects of these sectors make them less appealing to investors during a rising interest rate environment.

Energy has consistently underperformed immediately following a rise in interest rates. Energy lagged the market in the first month of the rate cycle in the last six episodes. Our previous ISM business cycle analysis showed Energy to be a late cycle outperformer vs. the S&P 500. Since our sample of rate increases typically occurred during the early and middle stages of the ISM cycle it is not surprising to see a back-test show the sector lags when interest rates begin to rise. Simple historical precedent suggests risk exists to our current Overweight recommendation in Energy. However, the potential for much higher oil prices highlighted by our colleagues in commodities research supports our overweight posture.

Financials are of particular interest in the current cycle. Our analysts believe higher interest rates and a steeper yield curve represent positives for the sector assuming economic growth is not derailed.

The longer-term pattern of sector performance during rising interest rate environments is less consistent and appears to depend on the source of higher interest rates (inflation vs. growth). The S&P 500 index rose over the course of the entire tightening cycles but sector performance was differentiated based on core inflation. Defensive sectors led the market when both interest rates and inflation rose while cyclical equities outperformed when rates rose without an inflation impulse.

Kostin's full presentation:


Charts That Matter 3.31

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Motorhead's picture

Silver, bitchez!

Spalding_Smailes's picture

Silver = Bubble 


1920 - $1.37

1947 - $0.60

1963 - $1.29

1968 - $2.56

1971 - $1.27

1974 - $6.70

January 21,1980 - $48.00

March 28, 1980 - $11.10

1982 - $4.88

1985 - $6.50

1989 - $6.00

1991 - $4.60

1995 - $6.10

2001 - $4.50

2005 - $7.50

2007 - $12.00

mberry8870's picture

If this is accurate how does one junk this?

blunderdog's picture

It's not uncommon for unpopular opinions to be junked in these here parts.  Even if the table is accurate, it might not support the opinion expressed above.

Silver in a bubble is a pretty silly idea, if you ask me, but I don't bother junking SS 'cause my bet is he's more troll than thinker.

Harlequin001's picture

so how are these figures supposed to denote a bubble?

blunderdog's picture

A "technical" trader who looks solely at lines based on changes in nominal pricing can apparently divine bubbles with a straightedge and a pen. 

Things like supply, demand, market disruption, changes in monetary supply are not ever relevant considerations.  It's a question of augury and faith.

Harlequin001's picture

faith, I like that. It's the ability to believe something despite the facts isn't it?

definite bubble then, long live silver, and long may it rise...

Spalding_Smailes's picture

Accurate down to the penny and dates ....


The junkers are mindless fools ..... They should turnoff mash re-runs and study up on things they invest in.

Rainman's picture

The 1980 high was a result of Hunt Brothers cornering manipulations. Surely there could be no such manipulation in SLV today !! ;>)

asdasmos's picture

@Spalding, could you please put up a historic dollar chart since 1913 as well, so we can contrast the silver gains please.

edit: I found one, is this accurate to you?

Maybe silver's gain has been 'backlogged' or 'manipulated' during the US $ decline, but that would never happen, right?

Dollar history.

1913 - $1.00
1920 - $2.02
1925 - $1.77
1930 - $1.69
1935 - $1.38
1940 - $1.41
1945 - $1.82
1950 - $2.43
1955 - $2.71
1960 - $2.99
1965 - $3.18
1970 - $3.92
1975 - $5.43
1980 - $8.32
1985 - $10.87
1990 - $13.20
1995 - $15.39
2000 - $17.39
2001 - $17.89
2002 - $18.17
2003 - $18.59
2004 - $19.08
2005 - $19.73
2006 - $20.18
2007 - $20.94 2
2008 - $21.57


akak's picture

And as bad and as damning as those figures are, they are lowballed by using the US government's politically-manipulated CPI figures, which understate the true extent of the ongoing depreciation of the US dollar.  A more realistic value for the multiple in the rise in prices from 1913 to today would probably be much closer to 30.

asdasmos's picture

Agreed, I was just about to edit in '(roughly)' next to 'Dollar history'. There are many estimates that are even higher that I agree with more, but even the conservative ones are damning.

hardcleareye's picture

This is an interesting discussion, boils down to what is the "true inflation" number.  The MIT and shadow stat indicatethat the decoupling on the CPI to "real inflation" started to happen in 1983 and has progressively widened since that time. 

*edit, erased bone headed math error

akak's picture

To be honest, I feel that John William's ShadowStats somewhat overstate the real rate of "inflation" --- which we really should call by its true name, currency depreciation --- but his rate is obviously closer to reality than the manipulated, and currently surreal, figures put out by the Bureau of Labor Bullshit Statistics.

LudwigVon's picture

Love ya akak. I agree with what you say in theory, let me just make a few comments on semantics so others can learn to decipher the MSM and other spin... 

Inflation = Increase in the quantity of money...

which leads to what John Williams speaks about = Price Inflation

(or) currency depreciating, but against what?

Dollar might be rising against real estate...

The process of inflation creates currency depreciation versus many assets, unevenly.

What I find 100% accurate is that we are seeing Inflation (NY Fed POMO schedule is about as hard of proof as it gets) in a deflationary environment (scary idea).



hardcleareye's picture



            Silver                                     Dollar

1920      1.37                                        2.02

1947      0.60                                        1.82

1963      1.29                                        2.99

1968      2.56                                        3.18

1971      1.27                                        3.92

1974      6.70                                        5.43

1980     48.00                                       8.32

1980     11.10

1985       6.50                                     10.87

1991       4.60

1995       6.10                                     15.39

2001       4.50                                     17.89

2005       7.50                                     19.73

2007      12.00                                    20.93

*didn't verify accuracy of numbers provided by others in blog

Harlequin001's picture

now why go and spoil a good story for the sake of a few facts, and figures...

savagegoose's picture

so 2001 was the best time ot buy silver with greatest devalued dollar vs lowest silver price

malikai's picture

Its not entirely clear what was happening with the Hunt's "cornering". What is clear is that there is far more to the story than meets the eye.

The Hunts seem to have began by hedging inflation (wise move in the 70s). Later, they got ahead of themselves and they were crushed by the machine. They became vulnerable by using too much margin, and this is where they lost the plot. Their financier banks knew what they were doing and let them have their way for a while; until they didn't. When the CFTC being only slightly less captured then as they are today hiked margins, the Hunts got cut to pieces and the so-called bubble burst. These are just my observations.

The entire silver complex could be busted today as well, if there are too many large hands unhedged or improperly hedged on margin. But I don't think it would last very long because once the currency is fully debauched, there is nowhere else to go but hard stuff, including silver.

sun tzu's picture

average price of cars


1912 = $240

2012 = $27,000


car prices must be in a bubble and will soon come crashing down to $240 again

r101958's picture

Excellent. Great analogy!

Pegasus Muse's picture

KingWorldNews has some outstanding guests this week. 


Listen to Rob Arnotthttp://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/4/1_Rob_Arnott.html

 (He is a mainstream financial guy – been a guest on all the MSM outlets.  Graham & Dodd award winner.  Advises some of the biggest funds in the world, PIMCO, etc.  He tells it the way it is.  Disgusted with what he's seeing.  Says what the Fed is doing is BS.)



Then listen to James Turkhttp://www.kingworldnews.com/kingworldnews/Broadcast/Entries/2011/4/2_James_Turk.html

 (Great insight into how the currencies and metals are behaving.  After a recent impressive 40% rise, silver is still strongly in backwardation.  This has never happened before in history.  Turk is watching gold carefully.  Says if gold goes into backwardation, which has never happened before, the US Dollar is toast.  Means people have completely lost a faith and confidence in the dollar.) 

The other KWN interviews are good but these two are superb.

Chuck Walla's picture

Thanks, that was worthwhile.

turfmac's picture

well said, rite on right on!

SamuelMaverick's picture

Two problems with the chart, one the prices are not adjusted for inflation, and two the cause of the recent ten year run up secular bull market in gold and silver are not taken into account. Silver is not in a bubble, and the forces driving it's rise are numerous.  Just looking at the St Louis Fed chart on M2 is enuf to make you run to a Precious metal dealer.    Yours, Maverick

atlee's picture

QE Bitches! Where ya been?

tmosley's picture

Silver is not in a bubble.  The dollar is.

But our delivery/shoeshine boy here is totally ignorant of basically every factor driving the economy, so his worldview is just about 100% upside down.

This is why he thinks delivery driving is a growth industry, even with diesel prices breaching never before breached barriers this early in the season.

Spalding_Smailes's picture

Nice non-answer, just more personal attacks to distract from said historical facts on silver, just face the facts, pimp ... 90 years worth of silver prices.

Silversinner's picture

In the 14th century silver was valued at $800+,

soon this price target will be broken.


akak's picture

Coincidentally, that was just before the goldsmiths and their bankster buddies started playing with paper money and fractional-reserve Ponzi schemes.

sun tzu's picture

hamburgers = bubble 


big mac 1967 = 45 cents

big mac today = $4.00


big mac prices will go crashing down to 45 cents soon

malikai's picture

Stop. Doctor says I'm not supposed to laugh like that.

Anonymouse's picture

I distinctly remember an old McDonald's commercial from when I was young, probably from the early 70s.  It had a stereotypical rich man (mahogany paneling and all) being delivered a hamburger, fries, and soda on a silver tray.  Then the butler giving him the change remaining from the $1 he had paid.


Of course, back then, McDonald's food was delivered fast, the stores were clean, and the people were friendly.


And we had to walk to school in the snow. All year long. Uphill.  Both ways.



agNau's picture

How about supply/demand figures to go along with those highly accurate numbers? Is there any difference through the historical progression, regards supply? Supply/demand issues are driving grains through the roof.(as well inflationary pressure from too many dollars supply) Until the Bernank waved his magic wand tulips were a dime a dozen. Remember their scarcity drove their price until the supply burst that bubble. We know how long new mines take. There is now increasing demand, for an asset in decreasing supply, that is seen increasingly as a store of value, and protector of wealth. Think I'll buy more.

Calmyourself's picture

You face the facts pee-boy.. 6,000 years of PM's representing the labor and lives required to pull them from the ground and then valued as a rare and truely stand alone marker of wealth.  The dollar is toast, whoever pays yo u to post this crap knows it.

bothsidesnow's picture

Well what is a bubble? I believe it is when a large percentage of global capital is allocated to one asset class. However, if you do the research less than 1% of available global capital is invested in the PM asset class (PM and PM mining stocks). I don't believe that is a bubble based on my definition of a bubble. If global capital allocations to the PM increase by 1% theoretically the price of PM will double and in my opinion a bubble still would not exist. So the projections of gold at 5k-6k and silver at $200 are realistic if 5% of global capital is allocated to the PM asset class and at that point a bubble still does not exist IMO.

I believe that large institutional investors will begin to increase their asset allocation to PM and other commodities as the prospect for real resource shortages become more apparent i.e. oil, corn, soybeans, wheat, etc. The simple fact is that we have experienced rapid population growth that is pressuring the ability of supply to keep up with demand for goods that sustain humans.

IMO there are two ways to get yours. Print more money and buy them thereby driving up the price as we see happening right now or forcefully take them. The US is doing both because we have the printing press and the military. I don't see this strategy ending any time soon and in fact it will only intensify and create a positive feedback loop in the price of commodities.


Bay of Pigs's picture

Actually I think 4.06 was the low in 2001.

And saying Spalding is total douchebag is very accurate as well.

Spalding_Smailes's picture

Get ready for that crow soup ....

Notice that price drop in the 80's, over 60% in a few months .... enjoy.

Notice that 90 year average.

Bay of Pigs's picture

Maybe if you spent some time actually educating yourself on PM's you would be taken seriously around here. Denial is no way to live brother... 


akak's picture

You are assuming that Snails wants an honest education, and to participate in a sincere and honest discussion, instead of indulging in what is clearly his real mission here, which is to spread disinformation and outright lies regarding the value of holding precious metals during a time of fiat monetary collapse such as we are in today.

Harlequin001's picture

Ah Spalding, we've answered this one last week. You ignored it if I remember correctly.

It appears you have nothing to say except the same thing over and over and over and over and over...

It's boring now...

You seem desperate to get people out of silver. What gives?

akak's picture

It appears you have nothing to say except the same thing over and over and over and over and over...

It's boring now...

Such is the way of dishonest and disingenuous trolls --- it is their Tao.  We saw the exact same nonsensical repetition of half-truths and outright lies from the former troll JohnnyBravo/MasterBates regarding gold.

You implicitly assume that they are here to engage in open and sincere discussion, using logic and facts and history to make their case.  How naive!  Do you not see that they have an agenda to peddle --- or more to the point, that they willingly serve some power with an agenda to peddle?

Harlequin001's picture

'You implicitly assume that they are here to engage in open and sincere discussion, using logic and facts and history to make their case'

not so, fact is every dog's allowed one bite, and he just had his.

You have to give someone the chance to fail before you can say that they failed. and Spalding failed.

Now he gets ignored...

sun tzu's picture

Maybe they're junking his opinion and not the data? Duh

worker pay = bubble

avg annual household income 1912 = $750

avg annual household income 2012 = $50,233


Therefore, the average pay of Americans will soon crash to $750 per year and we'll all starve to death. The numbers I posted were accurate, therefore, my conclusions must be accurate.

AndyR's picture

**Therefore, the average pay of Americans will soon crash to $750 per year and we'll all starve to death. The numbers I posted were accurate, therefore, my conclusions must be accurate.**


Unfortunetly, your conclusions might be accurate...

Long-John-Silver's picture

Bread in 1920 cost 3 cents. That same loaf of bread now costs $1.30. What is your point?

Spalding_Smailes's picture

What was bread in 2001 when silver was below $5.00 along its historic trend line.

Also I buy bread for $0.85 ....

emsolý's picture

you know you can always just sell short silver if you think it's a bubble and want to put your money where your mouth is. I'm 100% confident you'll find a buyer in 15mins.

sun tzu's picture

I thought you were basing your conclusions on 90 years of data. Now you want to shorten it to 10 years of data? The old bait and switch. Try selling some snake oil next time.