Duration of U.S. Equities

How sensitive are stocks to changes in interest rates?

January 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.

SUMMARY

  • Sectors and factors were not very sensitive to changes in interest rates on average
  • However, the averages are misleading as the sensitivity varies significantly over time
  • The duration of factors was more dispersed than that of sectors

INTRODUCTION

If equity investors are from Mars, then fixed-income investors are from Venus. Despite nearly all investors holding various combinations of stocks and bonds, the terminology of the asset class specialists seems as if they are from different planets. Equity investors talk about valuation multiples, sectors, and factors, while fixed-income investors discuss yield, credit spreads, and time to maturity.

Naturally, some concepts are being applied to both asset classes, and occasionally some terminology migrates from one domain to the other. Duration is a traditional fixed-income concept that has been applied to stocks on a regular basis. For bond investors this simply means the sensitivity of a bond to a change in interest rates, but how is this applied to stocks?

Theoretically, the price of a stock is determined by its cash flows and its terminal value, which are discounted back to the present by the cost of capital. The more value is attributed to the future, the greater the sensitivity to a change in the cost of capital, where interest rates are one of the key drivers.

Given this, growth stocks that generate little cashflow currently, but have the potential to generate a windfall down the road, should be more sensitive than value stocks that feature high dividend yields.

In this research article, we will evaluate the duration of U.S. equities.

DURATION OF U.S. SECTORS

First, we focus on measuring the duration of U.S. sectors, where we utilize data for 17 sectors from the Kenneth R. French data library. We calculate the betas using monthly returns and a 10-year lookback, where the yield of the U.S. 10-Year Treasury Note is taken as the independent variable (read Macro Variables in Factor Exposure Analysis). Naturally, there are more sophisticated models for measuring duration, but th