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How Stocks Correlate with Interest Rates

Monday, January 23, 2006
You may have heard analysts talking about correlations, how events affect stocks, or covariance in the past. What this means is the stock price is dependant on several factors. Some stocks have a correlation to an easily quantifiable value while others do not. For instance, the interest rate is a huge determinant to several industries such as construction.

Today I compared the covariance of several stocks from different industries. The main industries compared were construction, mortgage (MREITS), Tech, Gaming, and Energy. As you can imagine, the construction and mortgage companies showed a high correlation with interest rates. Where the interest rate went up, the stock prices went down. Then Gaming showed a weaker link between the two variables. Tech showed a very weak relationship to interest. Then energy showed a weak relationship that if interest went up, so did the price of the energy stock. Of course this was only done on one energy company (Exxon) so it is not conclusive of the whole industry.

This was just one test, and was not comprehensive by any means. While I did compare stocks for 5 years on their daily close prices, there are many other events which may have a strong correlation between stocks. Knowing the strength of a relation between two variables will help you get a better idea of what the stock will do in the future (The FED usually hints to where the interest rates are going.) This should be a useful tool for any investor who wants to understand and minimize their risks, and increase their profit. No one wants an increased risk because they do not understand what is going on, so this method should help out many investors.

I got my data from the FED on 30-year mortgage rates and put it in excel. Then I downloaded the stock data with corresponding dates from finance.yahoo.com and put it in excel. Then I used the covariance function on the two columns to determine the covariance. This will then give a number between -1 and 1 on how strong the relationship is. If it is near -1 that means the relationship is strong and when the mortgage goes up, the stock falls. If the relationship is near 1 it shows that when the interest rates go up, the stock goes up. The closer it is to 0, the weaker the relationship.

I attached the covariance spreadsheet that I compiled here: Covairiance.xls