Q.: I believe interest rates will rise as inflation rises. What effect would higher interest rates have on stocks? — Kyle is based in Little Rock. A.: While the impact of rising interest rates on bonds is obvious, rising rates are a negative for stocks, and no one knows how stocks will react if rates climb. That won’t stop a lot of individuals from making a forecast or proposing a theory.
One common argument made by people who believe equities would fall is the expense of doing business. The premise is that if interest rates rise, borrowing costs will rise as well. Debt servicing becomes more difficult as a result, making it more difficult for businesses to expand as greater costs lead to decreased profitability. The revenue argument is a typical one for why higher rates are good for stock prices. Higher rates, it is said, indicate a perception of a stronger economy and faster growth. Companies bring in more business when the economy picks up momentum, and higher revenue leads to larger profits. The two stories I just shared are far from the only ones, and both bulls and bears have counterarguments, cautions, and corollaries. Most of them are logical, therefore they can be persuasive. The data is also persuasive. All of the genuine research I’ve read demonstrates a near-zero link between interest rate fluctuations and overall stock market results in the United States. When interest rates rise, stock market indices sometimes rise, sometimes fall, and sometimes don’t move at all. Similarly, no clear trend exists to suggest that asset groups within the market, such as small-company stocks or value stocks, react differently when interest rates rise compared to other times. Whether you compare stock market returns to rate movements on one, five, or 10-year Treasury constant maturity rates, the correlations are quite low. In practical terms, the lack of connection means that even if you knew exactly what the change in interest rate would be ahead of time, you wouldn’t have a better chance of forecasting stock market activity than if you made a random guess. For more aggressive traders, this lack of predictive value can be an issue. For diversified long-term investors, this should not be an issue. That isn’t to suggest that interest rate increases won’t have an impact. They’ll do it. As a dependable predictor of stock market changes, they just haven’t mattered. If you have a question for Dan, please send him an email with the subject line “MarketWatch Q&A.” Dan Moisand is a financial advisor with Moisand Fitzgerald Tamayo, a firm with offices in Orlando, Melbourne, and Tampa, Florida, that serves clients nationally. His remarks are provided for educational reasons only and are not intended to replace customized advice. Consult your advisor about the best course of action for you. For the sake of brevity, certain questions have been altered./n
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