Stock investors have become increasingly worried about how the
market will react as the Federal Reserve ends its extraordinary
bond-buying program. I, myself, am of the generation that began
investing in the early 1980s, when the late market strategist Marty
Zweig regularly cautioned, "Don't fight the Fed."
Not to worry, says James Paulsen, chief investment strategist at
Wells Capital Management. Rising bond yields don't snuff out bull
markets. The real bull-market killer is a collapse in consumer
confidence. In general, Paulsen says, bull markets don't end when
Treasury bond yields hit their lows in a given interest-rate cycle
and turn up. Instead, stocks tend to continue climbing as the yield
on the ten-year rises, and fall apart only when consumer confidence
The Fed directly controls only short-term interest rates. But
through its so-called quantitative-easing program, the Fed has
bought massive amounts of government bonds--helping to hold down
long-term interest rates. Now the Fed is slowing its monthly bond
purchases and gradually plans to end the program as the economy
gathers momentum. That should, in theory, result in higher bond
Paulsen's notion turns conventional wisdom--not just Zweig's--on
its head. When money becomes more costly, so does everything else.
Companies pay more to borrow. So do customers. That has a dampening
effect on the overall economy. Why shouldn't stocks fall when the
Fed applies the brakes to the economy?
But Paulsen has the data to back up his position. In a report to
clients, he looked at ten major periods since 1967 when the
ten-year Treasury bond yield was rising and consumer confidence was
stable or rising.
On average, Standard & Poor's 500-stock index returned a
cumulative 22.7% during these ten periods. In only one of the
periods did stocks fall. That was from December 1976 to October
1978, when the S&P 500 lost 13.3%. In addition, Paulsen says,
"corrections" occurred when both bond yields and confidence were
rising in 1968, 1971, 1978 and 1984. (A correction is defined as a
loss of 10% to 20%; a bear market is a decline of at least
The biggest stock-market gains during one of periods of both
rising yields and rising confidence occurred during the 2002-07
bull market (49%) and in the latest leg of the current bull market,
which he says began in November 2012 (36.1% and still counting as
of April 9.)
A rise in bond yields hasn't choked off this bull market yet.
The yield on ten-year Treasuries has climbed from a low of 1.4% in
July 2012 to 2.7% today.
Paulsen says stocks can keep gaining ground because rising
yields are the product of a strengthening economy. "Stock investors
should stay focused on why yields are rising," he says. "Is it
primarily because of growing and broadening evidence of a stronger
and more sustainable economic recovery--a confidence-boosting
reason? Or, are yields rising primarily because of concerns about
the economy overheating and inflation emerging and about whether
the Fed is falling behind the curve--a confidence-destroying
Paulsen says that for now, "good news on the economy is good
news for stocks." He suspects a short-term selloff in stocks will
occur later this year--beyond the recent drop in high-flying
momentum stocks, mainly in tech and biotech.
But he thinks the bull market still has a long way to go.
Americans have been becoming more optimistic since February 2009,
when the Consumer Confidence Index bottomed at 25, not long before
the horrific bear market that started in October 2007 would come to
an end. But the index, which is calculated by the Conference Board,
a nonprofit business group, was still only at 82 in March. In past
recoveries, the index has typically peaked at levels of 120 or
higher. "People are finally coming out of a fetal position,"
is an investment adviser in the Washington, D.C., area.