Have you heard about the link between iPhone sales and incidences of deaths from falling down the stairs? The iPhone-stair death ‘effect’ is one of hundreds of ‘Spurious Correlations’1, identified by a Harvard Law student who created a website of the same name in which he charts ostensible similarities between different data sets to satirise the human tendency to mistake correlation for causation.
Some people may make the same mistake with investment, drawing cause-and-effect links between two variables and letting that drive their investment strategy. Take, for example, the idea that you should avoid the share market when the Reserve Bank is raising official cash rates.
Looking at 2022 in the Australian market, for instance, you might think that link has legs. The Reserve Bank of Australia (RBA) lifted the cash rate eight times, the fastest and steepest monetary policy tightening in decades. In the same year, the S&P/ASX-300 fell about 1.8%.
But a key rule with statistics, like walking down the stairs, is not to jump a step. If we look over a much longer period in Australia, 1980 to 2022—we see no obvious link. In years when rates rose, annual equity returns were as low as -12.9% and as high as 48.9%. In fact, some of the best annual returns, like 1985, have been in rising rate years. In years when rates fell, we see a similar wide range in annual equity returns, -38.9% to 66.8%.
Drawing conclusions about the relationship between rising or falling official interest rates and the equity returns is likely to be as productive as predicting stairway deaths from iPhone sales. As that Led Zeppelin song goes, sometimes all of our thoughts are misgiven.
RBA Cash Rate is obtained from the Reserve Bank of Australia. The S&P/ASX 300 Index (net div.) is not available for direct investment. Each year is categorised by rising (falling) rates if the RBA Cash Rate at the end of the year is higher (lower) than the RBA Cash Rate at the beginning of the year. Index performance does reflect expenses associated with the management of an actual portfolio.
Contributed by Warwick Schneller (PhD, CFA) Senior Investment Strategist and Vice President of Dimensional Fund Advisors.
1. ‘Spurious Correlations’, Tyler Vigen.
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