Throughout much of the 2010s, the financial markets were in a TINA (there is no alternative) environment. The Federal Reserve held short-term interest rates near 0% for much of the decade, and bond yields were paltry compared with the previous 50 to 60 years.
Much of the strength in the stock market was attributed to the idea that there simply was no investment alternative outside of equities. When fixed income and cash yields are so low, investors are forced to move further and further out on the risk curve to earn higher returns.
After the Fed went on one of the most aggressive interest rate hiking cycles in history to combat the highest inflation rates in 40 years, TINA is no longer. There are now plenty of alternatives for investors, and they are relatively safe choices. You can now find yields in the 4% to 5% range on money-market funds, CDs, savings bonds, online savings accounts, and boring old Treasury bills.
Just look at the yields on short-term U.S. government Treasuries:
This is a welcome development for those in search of higher yield for their cash or more stable parts of their portfolio. Obviously, inflation remains elevated so the real yields aren’t nearly as juicy as the nominal levels, but I’m not sure many retirees or fixed-income investors care considering how low yields were for the past decade-plus.
Now, the question for investors in the stock market is this: Do higher yields on relatively safe U.S. government debt securities mean lower returns for equities?
This makes sense in theory. A higher risk-free rate should mean lower valuations, a higher hurdle rate to accept risk and lower expected returns for stocks.
But financial market theory doesn’t always translate into the real world when it comes to the financial markets.
For example, there have been plenty of stretches in the financial markets where the stock market performed horribly even with the benefit of lower interest rates. And there have been times when rates were high, but the stock market did just fine for itself.
I looked at the average 10-year U.S. Treasury yields, the average three-month T-bill yields, and the S&P 500 annual returns by decade to see if there was any relationship between rates and stock market returns.
The highest average yields occurred in the 1980s, which was also one of the best decades ever for stocks. Yields were similarly elevated in the 1970s and 1990s, but one of those decades experienced subpar returns while the other saw lights-out performance.
Yield levels were more or less average in the 2000s, but the stock market performed terribly.
There are other variables I could have included here that would better explain these results—inflation, starting valuations, the performance of the economy, the direction of rates, etc. This is why it’s so difficult to look at a single variable such as rates to draw concrete conclusions about the impact on markets.
Context is often more important than the level of any one variable.
I also looked at the performance of the stock market when three-month T-bill yields averaged 5% for the entirety of a year. That’s been the case in 25 of the last 89 years. The annualized return for the S&P 500 in those 25 years was 11%. So in years with above-average risk-free rates, the stock market has actually seen above-average returns.
I’m not saying stocks are guaranteed to do well in a higher-rate environment. Maybe investors will be content with 5% yields this time around and lay off the stock market for a while. But history shows they’re not guaranteed to do poorly simply because cash is offering higher yields.
It’s important to remember that stocks are long-duration assets while T-bills are not. Just as stocks can fluctuate in the short run so, too, can the risk-free rate.
The good news for investors is a hotter-than-expected economy is now offering better risk-free rates than we’ve seen in years. The paradox here is it could require a slowdown in the economy to vanquish higher-than-average inflation. If that happens, risk-free rates are likely to fall as well.
Enjoy the high yields, but don’t expect them to last forever if the Fed gets its wish and slows down the economy.
Certain securities mentioned in this article may be currently held, have been held, or be held in future in the author’s personal portfolio or a portfolio managed by Ritholtz Wealth Management.
This article is part of Fortune’s quarterly investment guide for Q2 2023.