Stock Talk - Real Interest Rates vs. Stocks: A Dangerous Shift?

Starting point is 00:00:00 Investors, I've been asked a number of times why I have focused so much on real-time, real-time, real-interest rates. Remember, this is the spread between nominal interest rates and real-time break-even inflation rates. It's the premium a treasury bond investor demands above inflation for holding U.S. Treasury bonds. This will be a quick video on this subject and its history over the last few decades. Mainly, post-QE, that's quantitative easing, which occurred post-great financial crisis starting in late 2008, early 2009. and before that period. Let's look at the most recent, say 15 years post-great financial crisis in the onset of the Fed's QE Quantitative Easing Program, where they used their balance sheet

Starting point is 00:00:41 to buy and sell trillions of dollars of treasuries and mortgage-backed securities. Take a look at the 10-year weekly chart of the S&P 500 with the significant lows circled, as well as the last major top in late 2021 and early 2022. Let this chart sink in for a bit. From the lows in early 2016 to the current highs in early 2025, a 240% total return for the S&P 500, compounding at over 14% per year. But yes, significant drawdowns, including the COVID recession of minus 35% and the earnings recession of 2022, which the S&P 500 dropped over minus 25%, and when you add in inflation, over minus 35% in real terms. Okay, now look at the chart over the same period for the five-year real-time real interest rates.

Starting point is 00:01:33 Basically, this is the five-year treasury yield minus five-year break-even inflation rates. These aren't surveys of investors. These are real-time market pricing that are not often aligned with surveys. When making investment decisions, I'll take market data over survey data nine times out of ten because I've found surveys usually gauge feelings, and more often than not, investing based on one's feelings leads to poor investment outcome. What you'll notice is that overall, in general, since the great financial crisis ended and the Fed started its QE programs that lower trending real interest rates have been better for the markets and higher trending real rates have been bad. The peaks in five-year real rates have coincided with troughs and overall S&P 500. Look back. Late 2015, December 2018, October 2022, the lows in October 2023, April, Mayish of last year, and once again,

Starting point is 00:02:27 in August of last year. All the prior periods over the last decade coincide with market lows and good buying opportunities in stocks. Why? Probably because with the lower trend in real interest rates came the effect of higher P.E.s and multiples for U.S. stocks, more specifically, U.S. growth stocks, whose terminal value largely makes up their net present value of future cash flows. Investors, unfortunately, that reverse correlation of lower real rates and higher stock prices has been broken since the first quarter of 2025 with S&P 500 topping at or near 6,050, 6,150 from mid-December, 2024 through mid-February. Should this trend continue, it would likely be a loud alarm bell for our economy and cause

Starting point is 00:03:12 greater harm to U.S. stock markets. Why do I say this? Because prior to the onset of QE in 2009, lower trending real interest rates had been bad, not good for U.S. equities. Look at the weekly chart of the S&P. 500 from 1995 through 2015. So in this period dating back to the Allen Greenspan soft landing from 1993 through 1998, the run-up of the internet bubble top in the first half of 2000 followed by the three-year decline into 2003. You'll see the

Starting point is 00:03:42 recovery of the SP 500 from 2003 into the great financial crisis top in mid-2007 followed by the two-year collapse into March 2009. In the first quarter of 2009, the Federal Reserve threw everything at had at the markets collapse, including a new QE program. While the road has been rocky since that time period, including COVID-19, numerous wars, 9% inflation in 2021, and an earnings recession in 2022, compound annual return of US stocks.

Starting point is 00:04:12 More specifically, US growth stocks has been stellar over that time. Now look at the real-time chart of the five-year real interest rate from 1995 through 2015. Prior to the advent of QE, quantitative ease, in 2009, the S&P 500 declined when the five-year real interest rate was declining. It really has only been since after 2009 in the advent of QE that the S&P 500 and more specifically U.S. gross stocks were inversely correlated with this real interest rate. Why is this? I think that prior to QE in 2009 and earlier, the markets had taken this as a negative growth

Starting point is 00:04:48 signal, much as it's been since mid-December of 2024 when the one-year real rate plunders, from about 2% to 0 in 6 to 12 weeks on the back of rapid economic slowdown, or at least expectations of one caused by tariff and trade rhetoric out of DC and consumer unease. What are the financial markets thinking now? Most likely lower real-time, real interest rates equals softer U.S. economy, equals slower growth, equals lower earnings growth. And in the case of post.com, great financial crisis, COVID in 2022, growth and earnings contractions. Those were certainly the worst outcomes in prior real rate declines.

Starting point is 00:05:27 I find it pretty amazing. It was only two to three months ago. The most financial analysts on TV were parroting U.S. exceptionalism, a strong U.S. consumer, and they had concerns that interest rates were heading to 5.5.5% to 5.5%. Not the 4.5% that the current 10-year treasury currently sits at. Investors, if there is any good news out there, it's that the fast-twitch real-time real yields, like the 1-3-year, have come up off as 0. level the last two weeks, even though they did decline a little bit last week.

Starting point is 00:05:58 Take a look at the one-year real-time real-time rate. This is happening just as real-time inflation break-even rates have started to roll over. Not the survey data, but the real-time data that traders look at in the bond markets. Investors, the first quarter of 2025 economic slowdown is concerning, particularly given it looks to be self-induced and self-inflicted out of Washington, D.C. However, if you're panicking now, many indicators that have led rallies and stocks for this cycle, such as real-time interest rates and real-time inflation data, are strongly aligning to say the same thing. Try not to panic here. There should be a better opportunity in place in time higher to sell over the coming

Starting point is 00:06:36 three to five months if your investment allocation is mismatched with your risk tolerance. A repeat of the gloriously boring and straight lineup of 2017 under the first Trump presidency was a very unlikely scenario in our work. Even though I like to say, it's the same people managing the same money, doing the same things, so many times we can expect the same outcomes we didn't expect the great scenario of 2017 to play out again this year in 2025. The main reason we didn't expect a great and non-volatile 2025 was the fact that in 2017 Donald Trump focused on one and only one thing, lower taxes, and getting that policy through Congress. Lower taxes equals lower friction on consumers and corporations and shareholders love that.

Starting point is 00:07:21 The Republicans' linear focus on taxes caused the S&P 500 to move upward in a nearly straight line in 2017 at historically low volatility. Trump chewed out of the gate. President Trump is going for the stick approach, mimicking 2018 and initially skipping the carrot of taxes and deregulation. The new administration is taking on a myriad of policy changes in rapid fire manner, immigration, tariffs, forward policy changes in government firings and downsizing from Doge, while potentially good for taxpayers and citizens over time, in the short term, what did they do? They all increase friction in the economy. They all increased costs to the economy short term

Starting point is 00:08:00 as shareholders and financial markets hate added friction. Investors know that regardless of the path of the economy and the financial markets in the next few months, the investment team here at Oak Harvest will be there crewing the ship and adjusting our models where we can. We expect 2025 to be a very active year for active stock management. Until next week, have a blight of. weekend and please tell your family, loved ones, and friends how much they mean to you this weekend.

Starting point is 00:08:26 All content contained with an Oak Harvest podcast expresses the views of the speaker and is for informational purposes only. It is based on information believed to be reliable when created, but any cited data, indicators, statistics, or other sources are not guaranteed. The views and opinions expressed herein may change without notice. Strategies and ideas discussed may not be right for you and nothing in this podcast should be considered as personalized investment, tax or legal advice, or an offer or solicitation to buy or sell securities. Indexes such as the S&P 500 are not available for direct investment and your investment results may differ when compared to an index.

Starting point is 00:09:09 Specific portfolio actions or strategies discussed will not apply to all client portfolios. Investing involves the risk of loss and past performance is not indicative of future results.

Stock Talk - Real Interest Rates vs. Stocks: A Dangerous Shift?

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