Interest Rates Impact on Stock Prices
Now how do interest rates relate to stock prices? It’s also common sense - no memorization, just understanding things you’re already familiar with in your personal life. (You just didn’t know how much you already knew).
Lower interest rates mean that a company will pay less to borrow money, so the company automatically makes more profit. It means that its customers have to pay less to buy the products, and that helps sales. It means that alternate investments (like putting money in the bank) pay less. When that happens it makes the stocks more attractive. Those things together are overwhelming, and very often when interest rates rise, stocks go down, and vice versa. Now, watch this.
Sometimes what happens as the economy starts to improve a little bit, and as we get a few transactions going, interest rates start to rise. That’s simply because people are taking out loans; they’re out there actually doing something with the money. And by the way, I’m not talking about one-day interest rates; we’re talking now about 5, 10, 15, and 20 year interest rates. So the interest rates rise a little bit from the ‘death spiral’ they’ve been in.
In this case, as interest rates rise the stock market also rises because the ‘strength’ of the economy is helping both of them. It’s easy to see if you realize these things are not tied together with steel; they’re tied together with rubber bands. They move together, but there’s flexibility. And you can make generalizations but there will always be times when things are backwards. Like when people get really scared… like they did back in September of ‘08. At moments of extreme fear interest rates fall and stocks go down at the same time. That’s because in extreme cases the rules don’t apply. People do whatever they feel in panic.
*Excerpts from "A World without Borders" by Dan Frishberg
