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Rising Rates by Themselves Have No Predictable Impact on Stocks

Rising Rates by Themselves Have No Predictable Impact on Stocks

Rising rates by themselves have no predictable impact on stocks—rising rates coupled with other factors might.

The concept behind rising interest rates negatively impacting stocks is theoretically somewhat valid. Why? Because the value of a business is often defined as the cumulative net future earnings discounted back to the present by a valid interest rate. So, if interest rates go up, the discounter will be a more significant number, and the present value of the future earnings stream will be less. But other factors need to be equal to have this concept be valid. But other factors are never equal, and there are always multiplicities of factors going on at all times. Hence, no one factor is ever the singular force driving stocks, and it is always an assortment of factors.

The fact is other forces often parallel rising interest rates, and these forces can be positive and/or negative. Because of this, there’s no overwhelming feature in history that shows us rising interest rates are good or bad for stocks—people cannot accept this fact (for another parallel reason). One large mainstream idea people continue to believe is that high valuations should foretell worse stock futures than low valuations. So, when the stock market has a high historical valuation, many people tend to be more pessimistic than if the market has a low historical valuation. . .Take that last sentence back to my first paragraph. We know rising interest rates should discount the present value of future earnings streams more, lowering the valuation. But when you look at the history of valuations and interest rate adjusted valuations, there is NO correlation between valuation levels and subsequent stock market returns in any meaningful period moving forward (3-month, 1-year, 2-year, 3-year, and 5-year, etc.). The correlation coefficient is effectively zero after rounding.

In closing, don’t let people tell you rising interest rates are bad for stocks because it is not measurably true. When people (media, pundits, professors, etc.) repeatedly tell you something widely known, then remember it is old news, and it is already priced into the market (and is almost certainly incorrect).

Put to memory: A widely discussed fear of a false factor is a positive.

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