How does interest rate affect the stock market? (2023)

zinc indexthey are one of the main drivers of the macroeconomic environment and market confidence. Yes oneBancoCentralAny rate hike or cut could have a profound impact on the country's stocks, with some winners and losers along the way.

What are the mechanisms behind this relationship and how do interest rates affect stocks?

How does the interest rate affect the stock market?

alternativezinc indexthey often tend to negatively affect earnings and share prices. When high inflation forces central banks to raise interest rates, businesses face higher borrowing costs and higher payments on outstanding debt.

However, different types of stocks tend to behave differently in a high-yield environment. For example, growth stocks and cyclical stocks would underperform, while value and cyclical stocks trend relatively high.

growth stocks

growth stocksThey are rapidly expanding companies that need to grow and outperform the market. These stocks show the potential to generate earnings faster and are often comparedworth actions.

Growth stocks often take out loans that they are confident will repay because interest rates are expected to remain unchanged. Because these companies are generally in the early stages of development, debt is critical, and they typically have longer cash flow horizons and are therefore more affected by interest rates. higher.

Daniela Hathorn, Market Analyst at Capital.com explained:

"Growth stocks are more sensitive to future returns, and in a high interest rate environment, economic growth is expected to slow, which will affect future corporate returns."

worth actions

When central banks raise interest rates, value stocks often outperform the market and growth stocks. This is because they are generally less volatile.

Value stocks tend to be more established companies that pay consistently and regularly.dividends. Therefore, value stocks enjoy moredemand, even if people spend less.

Daniela explains:

“Value stocks are perceived as a better store of value in economically turbulent times; Therefore, when interest rates are high and capital investments are low, there is a high probability that the first allocation will be to value stocks as a means of capital preservation. until a certain point".

The analyst added that some value stocks are often considered the foundation of a balanced portfolio, so the impact of interest rate changes will be less significant.

cyclical actions

Andcyclical actionsMore affected by macroeconomic changes in the economy as a whole, they are more negatively affected by rate hikes than non-cyclical stocks.

When interest rates fall, the economy tends to stimulate itself. That means people have more purchasing power and consumers are buying more, which helps cycle inventories. Often it is restaurants, hotel chains or retail stores that benefit from increased consumer spending.

Conversely, when interest rates rise, cyclical stocks are negatively affected as consumers have less purchasing power. As a result, cyclical stocks could suffer a downward trend, according to Daniela:

“During periods of rising interest rates, cyclical stocks often underperform due to their high risk and volatility. In these times, investors generally look for safer and more stable returns to combat asset depreciation and therefore non-cyclical stocks are favoured.”

Bank stocks are an interesting example as they are cyclical but can also benefit from high interest rates, which increases your credit spreads. However, rising interest rates often follow inflation or precede recessions, so defaults can be expected, which can offset higher borrowing.

defensive measures

Also known as non-cyclical stocks, defensive stocks tend to be more stable regardless of current economic conditions, so they are less affected by recessions and interest rate hikes.

These are often utilities and companies whose products consumers cannot save even in times of tight budgets, such as drugs. As a result, when interest rates rise, defensive stocks are less affected because the demand for their products and services is still there.

How Interest Rate Changes Affect Bond Yields and Investor Sentiment

ConnectionPrices are usually inversely correlated with interest rates. Bond yield, on the other hand, is the amount an investor earns from a bond investment that increases when interest rates rise, and vice versa.

As Daniela from Capital.com explained, when interest rates are high, bonds become more attractive because they offer a higher yield:

"As a result, investors will be less willing to push stock prices because the value of future earnings will look less attractive than what they paid for bonds today."

leave something2008 financial crisis, the US Federal Reserve (federal) has gradually increased rates. In the graph below, we see that the fed funds rate increased from 2015 to 2017. We can also see that bond yields increase accordingly.

investor sentimenttends to change withmonetary policy, Also. A rate cut cycle typically results in arisk environmentand demands moreliquidityin markets as investors search for higher-yielding assets.

However, when interest rates rise, investors may become more risk averse and seek safety in bonds as yields become more competitive.

Relationship between interest rates and stock prices

Historical observations have shown that stock prices and interest rates are inversely related, that is, when interest rates rise, stock prices tend to fall.

In the chart below, which dates back to 1987, you can see that the S&P 500 Index (US500) tended to increase.

Key Factors Affecting Interest Rates and the Stock Market

There are several factors that affect interest rates and the stock market, but the key may well be the key.Inflationand economic growth. Policymakers often take both indicators into account when making interest rate decisions.

• Inflation: Rising inflation leads to higher interest rates. When prices rise due to inflation, corporate profit margins and growth suffer, resulting in lower investor confidence, which affects their risk appetite when holding stocks.

• economic growth: Negative economic growth can weigh on investor confidence and lead to a risk shift. Recession fears could also prompt central banks to boost the economy through rate cuts and quantitative easing (QE) as long as inflation is moderate.

Diploma

Interest is a fee for borrowing, but it is also a loan to save. High inflation causes central banks to raise interest rates and this has a ripple effect on businesses. High interest rates tend to have a negative impact on corporate profits and therefore stock prices.

However, different types of stocks tend to perform differently when interest rates rise. For example, growth stocks and cyclical stocks would underperform value and defensive stocks.

Rate increases and cuts can also shift investor sentiment between risk and risk, affecting bond yields. Higher interest rates tend to make bonds more attractive.

Historical observations have shown that stock prices and interest rates show an inverse correlation between interest rates and the stock market; h when interest rates rise, stock prices tend to fall. However, the data also showed that the stock market did not respond positively to rate cuts during the 2008 crisis, suggesting that the relationship may be weakening.

There are several factors that affect interest rates and the stock market, the most important being inflation and economic growth.

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