Last week, in a Chart-of-the-Day piece, I wrote about the impact rising interest rates could have on stocks.

There’s a strongly-held belief that higher interest rates always work against stocks. But that’s only half true.

The direction of interest rates is important. But the level of interest rates is just as important. And this aspect of the relationship between interest rates and stock prices is often overlooked.

Here’s the chart I shared. J.P. Morgan consistently publishes it in its Quarterly Guide to the Markets:

The chart plots the correlation between weekly stock returns and interest rate movements. It answers the simple question: “Do rates and stocks typically move in the same direction or in opposite directions.

The answer is: it depends on whether interest rates are above or below 5%.

When interest rates are above 5%, an upward trend in rates has historically weighed heavy on stock prices. This is the story most investors are told… higher rates make borrowing costlier, lending a cooling effect to the economy and investors’ expectations for stock returns.

But when rates are below 5%… an upward trend in interest rates has acted as a tailwind for stocks. Stock prices have historically moved higher, alongside higher interest rates, while rates are under the 5% threshold.

Rates are under 5% today.

The trend of rising interest rates will indeed act as a headwind for stocks… eventually. But it could be a while longer before that headwind kicks in.

Until we hit the 5% threshold, we could easily see stocks continue to rise alongside interest rates.

Some stocks, that is. Certainly not all stocks.

The thing with this sudden return of focus on inflation and interest rates is that it will spur shifts in investors’ preferences. As the threat of inflation grows stronger, and closer, we’ll see shifts away from rate-sensitive sectors – like utilities and real estate – and shifts toward sectors that are typically more robust to higher rates, like commodities.

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