It’s Still About Higher Rates: Dow Jones Industrials Gain 110 Points, S&P 500 Nears Record High

What a difference a day makes. After plunging yesterday, stocks gained today as investors came to terms with the Federal Reserve’s revised schedule for higher rates, sending shares of Invesco (IVZ), Zions Bancorporation (ZION), JPMorgan Chase (JPM) and Charles Schwab (SCHW) soaring.

Bloomberg

The Dow Jones Industrial Average rose 108.88 points, or 0.7%, to 16,331.05 today, while the S&P 500 gained 0.6% to 1,872.01, just 0.3% below its record high. Shares of Invesco rose 3.8% to $36.25, while Zions Bancorporation advanced 3.2% to $32.99, JPMorgan Chase gained 3.1% to $60.11 and Charles Schwab finished up 3.1% at $28.43. All might benefit from higher interest rates.

The big difference today, however, comes from the fact that investors have moved on from grief to acceptance when it comes to higher interest rates–and don’t expect them to derail the economy any time soon. Bianco Research’s Howard Simons, for instance, concludes that higher two-year Treasury yields might benefit the overall stock market, even if they hit some industries:

Twenty-nine industry groups accounting for 24.58% of the S&P 1500's market capitalization, have statistically significant negative relative performance betas to two-year Treasury yields…Six of these groups are REITs…

Thirty-six groups accounting for 28.98% of the S&P 1500 have a statistically significant positive relative performance beta…Non-REIT financials, Industrials, Energy and Technology…are represented heavily.

Each 1% increase in two-year Treasury yields, about 0.4195 basis points, would lead to a 0.0011% increase in the S&P 1500, all else held equal.

MKM Partners’ Michael Darda believes that the Fed’s critics “have utterly failed to…interpret financial market signals properly.” He explains:

First, the QEs have not lowered long rates (QE on periods have been associated with rising long rates), but they have played an important function in placing a floor under long run inflation expectations. Second, financial markets do not expect an overshot on the Fed's 2% inflation goal, despite the Fed having missed its inflation target to the downside on average since the recovery began. Nonetheless, Yellen's Balanced Approach model suggests the Fed has done a sufficient volume of OMOs at this point to push the shadow short rate below the natural or equilibrium rate. This should be associated with a period of above trend growth, something the Fed wants in order for the labor market to more fully heal and inflation to return to target. With some cushion now in place, the bar is probably pretty high for any reversal/halting of the tapering process, despite the financial commentariate falling all over itself to speculate about the Fed calling off the taper when labor market data weakened in December and January (we believe mostly due to weather and thus likely to reverse). If the model is even in the ballpark, the early stages of Fed tightening sometime in 2015 should not be a threat to the recovery.

Today, at least, the market seemed to agree.