Ever wonder why the stock market does what it does?
One factor that affects the market is interest rates. I always thought that when rates went up, stocks went down because more people are tempted to put their money into safer interest-bearing accounts rather than equities.
That may indeed be true, since as rates climb, such safer investments have bit more appeal. But the interest rates on savings never quite go up as much, or as quickly, as rates that are applied to money you owe, such as credit card balances.
Plus, people who are primarily interested in these safer investments probably aren't putting too much into the stock market in the first place. They don't like the dramatic ups and downs.
I don't either, but as I look at some of our investments that we've held onto during down times, they've bounced back nicely. And during those periods, our dividend reinvestment participation meant that we were able to automatically purchase even more shares of the holdings.
One of our investments is a Fidelity mutual fund and in our latest newsletter, this discussion of rising interest rates and their effect on investors caught my eye. It's the clearest explanation I've seen of this phenomenon.
Rising interest rates can boost the interest you earn on a money market deposit account or a passbook savings account. But a rising rate environment is generally bad news for stocks and bonds. Higher rates represent increased interest costs for many companies. And because higher rates often are a response to inﬂation, they can signal that corporations are encountering other cost increases as well. Bond prices generally move in the opposite direction of interest rates, so it's easier to see why bonds react badly to rising interest rates. But generally, rising interest rates will have less impact on bonds with shorter maturities and higher coupons.
Not being a corporate titan, I hadn't thought about the associated business costs that are directly affected by interest rate. Higher business costs = less profit = unhappier shareholders = a falling market.
So on this Fed Day, with the Federal Open Market Committee getting ready to raise rates once again this afternoon (Greg McBride, Bankrate.com's resident Fed expert, says to expect a quarter-point hike), I thought I'd share the investment/interest rate connection just in case you were wondering, too.
And now I finally know exactly why I wish Bernanke and crew would just keep their mouths shut!