Interest Rates, Equities, Recession?

Recession = interest rates down but interest rates down doesn't = recession

Hello everyone,

There has been some confusion among people in the news media and social media regarding how the relationship between stocks and bonds functions in both the presence and absence of a recession. For example, I keep hearing that if rates are going to come down, a recession is likely to occur. This is a conflation of two separate variables.

While rates typically fall during recessions, a fall in rates doesn’t mean there is a recession.

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First, notice that interest rates can trend down for prolonged periods without a recession occurring. The fact that interest rates move down is often the reason a recession DOESN’T happen.

I have laid out the big picture of equities and rates here:

Remember, equities and bonds can rally TOGETHER for a prolonged period of time.

Thinking in a zero-sum way between stocks and bonds generates extreme views that don’t generate positive returns. For example, people thought that bonds had to rally if stocks sold off.

2022 crushed that false notion:

Then people believed that since bonds were rallying during 2023 that a recession was imminent. Then stocks and bonds rallied together:

If you want to dig into this more, this is one of the main papers on the stock-bond correlation is this: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3075816

Just remember, people are always going to extrapolate a single part of the system to the whole. Your goal should be to see how each part of the system uniquely contributes so that the whole is GREATER than the sum of its parts.

The yield curve (and outright rates) function in a reflexive feedback loop with nominal growth. This creates path dependency between the two. I touched on this idea in the interest rate primer:

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Main takeaway: I still have the view that a recession is unlikely in 2024. If the evidence changes then I will change.

If you want some homework, go look at 2019 and how much the ISM decelerated while the market rallied to all-time highs. Perma bears were having the time of their lives in 2019 on this divergence.