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MarketScape · 10.23.23

The Puzzle of the Equity Market's Reaction to Rising Rates

Equity index multiples have barely budged with rising interest rates, but rates still are driving returns in most individual stocks. Deputy CIO and CIO of Global Equities Michael Hunstad, Ph.D., examines why this may be happening.
Market Views
Equity Insights
Markets & Economy
Key Points
What this is
We analyze why, amid rising interest rates, the S&P 500 Index price‑to‑earnings multiple has remained stable.
Why it matters
Investors normally expect rising interest rates to shrink equity multiples, making the current trends confusing.
Where it's going
Most stocks still are sensitive to interest rates, but the dominance of rate‑insensitive large tech companies in the S&P 500 makes the equity market appear less sensitive to rates.

Despite real long-term interest rates spiking to 20-year highs, equity index have barely budged, leading some market pundits to conclude equity returns are largely impervious to rising rates. In stark contrast, most of the variation in individual stock returns is directly explained by interest rate exposure. So far in the fourth quarter, the most sensitive stocks significantly underperformed the broad market while the least sensitive significantly outperformed. This divergence is confusing, as it shows two very different forecasts of the future real rate path. Index multiples suggest a rapid decline in rates while individual stock returns indicates that high rates may be here to stay. Let's take a closer look.


Real 10-year yields have risen more than 100 basis points since June to levels not seen since the Global Financial Crisis. Despite the sharp increase, the forward price-to-earnings multiple of the S&P 500 index has contracted only slightly. Moreover, a historical regression of real rates on equity multiples would suggest current interest rates would support a forward price-to-earnings multiple of about 14, much lower than the current multiple of just below 18. Some have argued that the failure of equity multiples to adjust to rising rates means real rates are likely to drop quickly in the future.


On the other hand, sensitivity to long-term real rates can explain the majority of the recent variation in individual stock returns. In the last quarter, S&P 500 stocks that are highly sensitive to long rates, as measured by macroeconomic risk models, have underperformed the benchmark by more than 5% while the least-sensitive stocks have outperformed by about 3%. This extreme price action suggests interest rates may remain elevated. So which view on the future rate path appears most likely?


We feel real interest rates will tend to remain high, as reflected in individual stock performance. Index have been propped up by a few large tech names that have experienced large AI-driven expansion even though these stocks have come under pressure in recent weeks. The narrative that equity markets are immune to rising real rates is essentially a bet on the stability of these tech multiples in the face of rapidly shifting prices in other parts of the market. This bet represents a significant concentration of risk exposure and may call for a move into more diversified equity strategies.

Main Point

Interest Rates Still Matter to Most Stocks

Sensitivity to long-term real rates can explain the majority of the recent variation in individual stock returns. In the last quarter, S&P 500 stocks that are highly sensitive to long rates, as measured by macroeconomic risk models, have underperformed the benchmark by more than 5% while the least-sensitive stocks have outperformed by about 3%.

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Michael Hunstad, Ph.D.

Deputy Chief Investment Officer & Chief Investment Officer of Global Equities

Michael Hunstad is deputy chief investment officer and chief investment officer of global equities for Northern Trust Asset Management. Michael is a member of the Asset Management Executive Group and has oversight of all equity portfolio management, research and trading activities including quantitative, index and tax-advantaged strategies. Additionally, he assists with the development of investment vision, strategy portfolio construction and risk management framework for the firm’s broad investment platform.

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