Short Term Impact
When interest rates are rising or if investors anticipate a rise, many will sell bonds or some of their bonds to avoid the fall in prices and buy stocks. This commonly results in stocks rising while bonds are falling. Like bonds, not all stocks react the same way to rate hikes. In fact, some sectors historically perform well during periods of rising interest rates. For example, banks typically have stronger earnings because they can charge more for their services. Rising interest rates also tend to favor value stocks over growth stocks because of the way many investors calculate a stock’s intrinsic value. Rising interest rates makes these investors demand more for their investment dollars, so they’ll commonly turn to stocks that have a history of earnings growth. Of course, past performance is not an indicator of future results.
Long Term Impact
However, over time, rising interest rates can have a negative effect on stock prices. Higher interest rates make it more expensive to borrow money. A business that doesn’t want to pay the higher cost for a loan may delay or scale back projects. This, in turn, may slow the company’s growth and affect its earnings. A company’s stock price generally drops when its earnings decline.
Also, rising rates increase margin rates or the rate in which traders borrow money to trade stocks. The higher rates make trading on margin less profitable, and many traders often cut back the amount of margin they use, which means there’s less demand for stock shares.
Finally, rising rates typically lead to a stronger dollar, which may put additional pressure on the stock prices of multinational companies because it becomes more expensive to do business in some countries.