High Interest Rate Effects to Stock Market

High Interest Rate
Is A Must In World Economic Condition
Generally, we are susceptible to high interest rate whenever inflation skyrocketed. And interest rates, which change over time, play an important role in affecting the stock market. They determine what other investment instruments might be.

Naturally, investors will select an investment with return high enough to compensate for the lost opportunity of earning interest from the guaranteed Cash Deposit (CD); or some called it as Fixed Deposit, offered by banks, and for taking on additional risk.

CD is a short to medium term insured investment made available by banks. When you open a CD account, you agree to lend your money to the bank for a certain amount of time. In return, you are paid interest.

If a bank is paying as high as ten per cent in interest for cash deposit annually, lots of people will prefer to deposit their money in that bank than invest in the stocks (as well as mutual funds).

As such, not many buying and selling activities will take place in the stock market. This especially true during economic downturn or recession . During economic crisis, CD’s interest rate can increase to seven to ten per cent. During that time, almost everyone preferred to save their money in the bank than investing in the stock market.

Looking from another perspective, interest rates affect a company’s operations too. If a company borrows money from a bank, the high interest rate will raise the company’s cost of doing business. Therefore, a company has to work harder to generate higher returns and at the same time, aggressively cut its operational costs. Otherwise, the high interest rate will eat up into its profits.

Moreover, if interest rates rise to a level where the company has problems paying off its debt, then the company’s survival may be in jeopardy. In that case, investors will demand an even higher risk premium. As a result, the fair value of the stock will fall even further.

For example, instead of paying $20 per share, you may be willing to pay only $13 per share as its fair value. The reason is, as the bank increase CD rate which results to higher interest rate, you may adjust your expected return from that stock.

And finally, high interest rates normally go hand in hand with a sluggish economy. They prevent people from buying new cars and houses.

As sales and profits drop, so does its stock price. That is why the market cheers when the government announces and interest rate cuts. But if the government raises the rates, the market will fall.

However, we must understand that US Federal Reserve is not actually interested in knowing whether stock prices go up or down. They are only interested in growing economy on a sound fiscal policy. An overheated economy will lead to high inflation rate, which is bad for the economy overall. The authority left no choice than raising the interest rates to cool in down.

So what should you do when interest rate are changing?

For long term stock investor , do nothing! Since you are investing in the business itself, interest rate should not be the deciding factors on how you invest in stock market. It is more of a technical factor in driving current conditions. What should be your main concerns are goals in investing in the stock market as well as your timeframe.

As individual long term stock investor, either increase or decrease in interest rates should not make a great deal of difference. As such changes only affect short term investments, not for long term though.

But for short term stock trader , you have to get out of the stock market as quickly as possible.

Else, you risk losing all your money the longer you stay in the market.

Even if you are already losing the money, stop your losses as soon as possible.

As I said, losing $57,000 is better than losing $650,000 later!

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Stock Market - Do you Know What Exactly Moves It?
Other factors that affect stock market performance.

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