Forecasting Stocks In 2022? Watch The Fed

Investors know that the bond market matters for stock prices. Recent research reveals how important this is. If the U.S. does hike rates materially in 2022, especially at a faster rate than other countries, then the impact on the stock market is unlikely to be positive.

Stocks and Bonds

Adam Zaremba of Montpellier Business School and colleagues have looked into the relationship between yield curves and stock returns across multiple countries. Specifically they examine at the change in the yield in 10-year government bonds. Their paper is titled Yield Curve Shifts and the Cross-Section of Global Equity Returns. It examines sixty countries from 1921-2020.

They find that countries with the greatest increase in bond yields tend to see weaker stock price performance. Specifically, those countries in the highest quintile of rate increases tend see their stock markets underperform those countries in the lowest quintile by 0.76% a month. That suggests that, all else equal, investing in countries that are rising interest rates at a relatively fast rate is best avoided by stock investors.

Fed Hikes

The Fed has signaled that it may raise rates three times in 2022 and the bond market appears to broadly concur with that view. Most assessments have U.S. rates rising to some degree. That does not bode well for the stock market, though according to research the metric to watch is the change in the yield on the 10-year government bond rather than the specific number of rate increases, and, importantly how that change compares with other countries.

The Example Of Turkey

Turkey gives one extreme example of this relationship in 2021. Over 2021 the yield on the 10-year Turkish government bond has risen from approximately 13% to 25% and Turkey is among the worst performing stock markets for 2021. This also offers some hope to the U.S., even though yields may rise, the shift is unlikely to be as extreme as some other countries.

Nonetheless, there is no shortage of research demonstrating that rising rates are often a negative for the stock market. If the Fed does stick to its plan to raise rates in 2022, then that may well prove a drag on stock returns.