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Interest Rate Increases and the Stock Market

February 1, 2022 | Commentary

  • The Federal Reserve has clearly indicated its intention to end quantitative easing this year and begin raising policy interest rates.  With inflation well above target and unemployment below 4%, the market has long anticipated these moves.
  • The most basic principle in stock analysis is that today’s price should reflect the discounted present value of a company’s future earnings.  As interest rates rise, and all other parts of the equation remain unchanged, stock prices should fall.
  • The challenge is that all other parts of the equation never remain unchanged.  It matters why interest rates are rising and companies will be affected differently depending on how they respond to economic forces, their current versus expected future earnings, and their need to borrow to access capital.
  • The market historically gets the general pattern of these changes correct, but it is a noisy process prone to exaggerated moves.  The alpha of successful active managers never displays the consistency of T-Bill returns, necessitating patience to avoid emotionally driven new investments or redemptions.

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