Duration of U.S. Equities – II

How sensitive are stocks to changes in interest rates?

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

SUMMARY

  • There are multiple ways to measure interest rate sensitivities
  • “High-duration” stocks like tech and biotech were not more sensitive to rising rates
  • The relationship between interest rates and stocks is weak

INTRODUCTION

In our first article on the duration of U.S. equities (read Duration of U.S. Equities) we concluded that the interest rate sensitivity of the stock market ranged significantly between 1973 and 2023, which was difficult to explain and also questioned the usefulness of such information. Furthermore, we observed that factors like value or momentum did exhibit different sensitivities, but almost all sectors showed the same trends in sensitivity as the S&P 500.

However, these results conflict with the consensus view that the implosion of the tech and other bubbles in 2022 was caused by the rise in interest rates, where some sectors are supposedly more sensitive than others. Intuitively, increasing yields should deflate excessive enthusiasm in highly speculative investments like unprofitable tech companies, biotech stocks, cryptocurrencies, and 100-year bonds. Investors are more hesitant to undertake risky investments when short-term deposits or bonds pay 4% to 5%.

Given this, we will explore the duration of equities further in this article.

MEASURING INTEREST RATE SENSITIVITY

It should not be complicated to measure the interest rate sensitivity of a security. However, if we take a time series like the U.S. 10-Year Treasury Yield as the independent variable in a regression analysis, then we need to decide whether to take the absolute change or percentage change in yield. Given that yield itself is a percentage, it can be argued that the absolute change is more relevant (read Macro Variables in Factor Exposure Analysis).

We compute the rolling one-year betas of Fidelity’s Investment Grade Bond Fund (FBNDX) using the absolute and percentage change in the yield, which highlights similar trends between 2002 to