V.9:7 (264-266): How interest Rates Affect Stock Prices by Mark C. Snead

How lnterest Rates Affect Stock Prices by Mark C. Snead

The basic theoretical relationship between changes in long-term interest rates and stock prices is inverse. Falling interest rates signal rising stock prices, while inversely, rising interest rates signal falling stock prices. Changes in interest rates affect stock prices inversely for two distinct reasons.

First, as interest rates fall, corporate borrowing costs (to fund expansions, acquisitions, inventories and so forth) decrease, and the outlook improves for future corporate profits. Investors view stock ownership favorably when corporate profits improve. Second, when interest rates on long-term debt instruments fall to lower, less attractive levels, investors gain the incentive to seek the historically higher long-term returns that equities offer.

In both cases, investors react to lower long-term interest rates and so direct investment funds toward stocks and away from bonds. The opposite is true for rising long-term rates.