Interest Rates and Impact on Equity Valuations
Interest rates have been at historically low levels for years now – at or near almost 0 since the financial crisis of 2008. This has fueled cheaper borrowing costs, lower costs of capital, and general economic growth. However, recent inflation has spurred a series of rate hikes back to more ‘normal’ levels, and the interest rate environment is set to continue rising for the foreseeable future. How does this impact the stock market and equity valuations?
As with most things, it isn’t a one-size-fits-all answer. Different businesses are impacted in different ways by rising rate environments – some positively, and some negatively. Take bank stocks for instance: during a rising rate environment, banks actually tend to do better because their margins increase (most banks primary source of revenue comes from earning the difference on interest rates between what is borrowed and what is lent out). Speculative tech stocks, on the other hand, tend to experience more valuation difficulties with rising rates, as cost of capital increases and so it becomes more expensive to borrow and spend money.
As a general rule, rising interest rates tend to lead to lower stock valuations as a whole. In addition to business-specific reasons, stock market valuations tend to decrease because bond yields go up. Higher yields today on bonds provide investors with more of an incentive, and this can lead to less demand for stocks (and thus lower prices).
As always, it’s important to do your own research on how rates can impact your investment strategy!
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