The talking heads have successfully put everyone back on their heels at the faintest whispers of rising interest rates. Could we be close to a major, multi-decade structural shift in interest rates? Possibly. That being said though, rising rates do not equate to Armageddon for financial assets. It's important to realize that the FOMC does not explicitly control long term interest rates. They can influence them through operations like Quantitative Easing, but those operations have since concluded in the U.S. The FOMC actually sets the discount rate, which impacts short-term overnight loans between large financial institutions. The level and movement of long term rates, like 10 year U.S. Treasury yields, are driven by the collective inflation and economic growth expectations of the market. Rising rates are typically a byproduct of economic expansion, which in turn, results in greater demand, tighter inventories and price inflation.

The table below reviews the return of broad asset classes during rising rate environments from 1970 to present. Rising rates are defined as those periods where the U.S. 10 year Treasury rises by 1% or more over a 12 month period. I use 10 year Treasury's because, unlike the short-term discount rate, they reflect market expectations as noted above. Unsurprisingly, 10 year Treasury's perform poorly in rising rate environments--down -4.0% annualized on average. As you move from left to right on the "average" line, gradually moving to more volatile asset classes, you find that total returns generally improve. Commodities actually perform well strong in rising rate periods, which is contrary to the market action of the last year with gold and oil down significantly.

With proper understanding, rising rates should not be feared. The historical record suggests risky assets, like equities and commodities, do quite well in rising rate environments. Investors that have properly diversified portfolios across multiple asset classes have little to fear. However, moving forward investors should not expect the low, bond-like volatility and high equity-like returns experienced over the last few years. Major inflection points in markets tend to result in increased volatility. Set an asset allocation and stick to it.