Real Interest Rates vs. Stocks: A Dangerous Shift?

I’ve been asked a number of times why I focus so much on real time real interest rates?  Which is the spread between nominal interest rates and real time breakeven inflation interest rates?  It’s the premium a Treasury bond investor demands above inflation for holding US Treasury bonds. This will be a quick video on this subject and its history the last few decades. Mainly post QE, Quantitative easing which is post GFC in 2008/9 and before that period.

Let’s look at the most recent 1o015 years post great financial crisis and the onset of the Feds “QE, quantified easing programs” where they used their balance sheet to buy and sell Trillions of dollars of Treasury and MBS securities. Here’s a 10-year weekly chart of the SP500 with the significant lows circled as well as the last major top in last 2021, early 2022.

Let this chart sink in for a bit.  From the lows in early 2016 to the current highs in early 2025, +240% in total return for the S&P500 compounding at over 14% per year, but yes significant drawdowns including the Covid recession of -35% and the earnings recession of 2022 which the S&P dropped over -25% and 0ver -35% in real terms including inflation.

Ok now here is the chart over the same time for 5-year real-time real interest rates.  Basically, this is the 5-year Treasury yield minus the 5-year Breakeven inflation rate.  These aren’t surveys of investors.  These are real-time market pricings which often are not aligned with surveys.  When making investment decisions, I will take market data over survey data 9 out of 10 times because I’ve found surveys usually gauge “feelings” and more often than not, investing based on one’s feelings leads to poor investment outcomes.

What you’ll notice is that overall, in general, since the Great Financial Crisis ended and the Fed started QE, that lower trending “real interest rates” have been better for the markets and higher trending real rates have been bad.  The peaks in 5-year real rates have coincided with troughs in the overall S&P500. Peak in real rates in late 2015, December 2018, October 2022, October 2023, April/Mayish last year and again in August 2025.  All of these prior periods over the last decade coincided with market lows and good buying opportunities.  Why? Probably because with the lower trend in real interest rates came the affect of higher PE’s and mulitples for US stocks and more specifically, US growth stocks whose terminal value largely makes up their net present value of future cash flows.

Unfortunately, that reverse correlation of lower real rates and higher stock prices has been broken since the 1q2025 SP500 top near 6050-6150 from Mid-December 2024 through Mid-February.  And should this trend continue, it would likely be an louder alarm bell for our economy and cause greater harm to the US stock markets.  Why do I say this, because prior to the onset of QE in 2009, lower trending real interest rates had been bad, not good for US equities.

Here’s a weekly chart of the SP500 from 1995-2015.  So this is the time period dating back to the Alan Greenspan soft landing from 1993-1998, the runup of the intent bubble top in the 1h2000, followed by the 3 years decline after into 2003.  You’ll see the recovery of the S&P 500 from 2003 into the GFC top in mid-2007, followed by the 2 year collapse into March 2009.

In the first quarter of 2009, the Fed through everything they had at the markets collapse including the new program of QE.  While the road has been rocky since, including Covid, wars, 9% inflation in 2021, and an earnings recession in 2022, the compound annual return of US stocks, and more specifically US growth stocks has been stellar.

Now look at the real-time chart of the 5 year real interest rate during this period, 1995-2015.

Prior to the advent of QE, quantitative easing in 2009, the SP500 declined when the 5 year real interest rate was declining. It really has been only after 2009 and the advent of QE, that the SP500, and more specifically US growth stocks, were inversely correlated with real interest rates.  Why is this? I think prior to QE, in 2009 and earlier, the markets took this as a negative growth signal.  Much as it has been since mid-December of 2024 when the 1-year real rate plunged from 2% to zero in 6-12 weeks on the back of a rapid economic slowdown, or at least expectations of one caused by tariff and trade Rhetoric out of DC, and consumer un-ease.

What are the financial markets thinking?  Most likely, lower real-time interests rates, equals a softer US economy, equals slower growth, equals , lower earnings growth, and in the case of post Dot.com, GFC, Covid, and 2022, growth and earnings contractions.  Those were certainly the worst outcomes in prior real rate declines.

Pretty amazing, it was only 2-3 months ago, that most on TV were parroting “US exceptionalism, a strong US consumer, and concerns that interest rates were heading to 5.25-5.5%, not the 4.25% that the current 10-year Treasury currently sits at.

If there is any good news here, its that the fast twitch Realtime real yields like the 1 and 3 year and come up off the zero level the last 2 weeks, even though they decline a bit last week.  Here’s the 1-year real time rate.

This is happening just as real time inflation Breakeven rates have started to roll over.  Not the survey data, but the real time data that traders look at in the bond markets.

Investors, the 1q25 economic slowdown is concerning, particularly given it looks to be self-induced and self-inflicted out of DC.

However, if you’re panicking now, many indicators, which have led rallies in stocks for this cycle, such as real time interest rates and real time inflation data, are strongly aligned to say the same thing, try not to panic here.  They are trying to say there should be a better place and time higher to sell in the coming 3-5 months if your investment allocation is mismatched with your risk tolerance.

A repeat of the gloriously boring and straight line up of 2017 under the first Trump presidency was a very unlikely scenario in our work.   Even though I like to say, it’s the same people managing the same money, doing the same things, so many times we can expect the same outcomes, we didn’t expect the Great scenario of 2017 to play out this year in 2025.

The main reason we didn’t expect a great and non-volatile 2025 was the fact that in 2017 DJT focused on one and only one thing, lower taxes and getting that policy through congress.  Lower taxes equal lower friction on consumers and corporations and shareholders love that! The GOPs linear focus on taxes caused the SP500 to move upward in 2017 in a near linear and historically low volatility year.

DJT 2.0 out of the gate, President Trump is going for stick approach, mimicking 2018 and initially skipping the carrot of taxes and deregulation. The new administration is taking on a myriad of policy changes in rapid fire manner.  Immigration, tariffs, foreigner policy changes, and government firings and downsizing by the DOGE, while potential good for taxpayers and citizens over time, short term do what?  They all increase friction in the economy.  The all increase costs to the economy short term and shareholders and financial markets hate added friction.  Is this max friction?  Was April 2^nd, Trump so called Tariff liberation day “max-pain”? Time will tell.

While all these policies in DC are anti economic growth in the short-term, real-time inflation expectations looked to have peaked while real growth expectations have troughed just as others say the reverse.

As a voter you don’t have to like him or his policies, but that isn’t what investing is about. They are about policies of growth and friction and currently the administrations policies are all anti-growth which the markets seemed to awake to in mid-February.

Soft landings in the economy do NOT guarantee no volatility. During The soft-landing that Alan Greenspan induced in 1996 in the midst of the internet buildout, we saw a -11% selloff.  Almost the same % decline we have witnessed in this 1q25 economic slowdown.  Is this just a Presidential slowdown and AI cycle slowdown to be followed be an acceleration in 2h25? Is this merely a halftime pause?  This time around, the Trump administration seem to be going for the early, “shock and awe”, taking on the tough policy issues first.  Are the carrot policies coming in 2h25 and 2026?

The good news? We are oversold and historically speaking, nearing what is normally a low in both economic growth expectations in the 1q, a seasonal low in the stock markets, and yes, a seasonal high in inflation concerns.

Investors know that regardless of the path for the economy and financial markets in the next few months, the investment team at OHFG will be here manning the ship and adjusting our models and long/short hedge equity fund where we can. We expect 2025 to be a very active year for active stock management.

Until next week, have a blessed weekend and please tell your family, loved ones and friends, how much they mean to you this weekend.

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