World Map for Stocks #02: Why do stock prices tend to fall when interest rates rise?

“When interest rates rise, stocks fall.” This is a phrase often heard in market explanations. Last time, we considered interest rates as the price of borrowing money. So, why does the movement of that price affect stocks? First, let’s look at it from the perspective of companies.When a company builds a factory or opens a new store, it sometimes uses loans. If interest rates rise, the cost of new borrowing or refinancing may increase. Even for the same project, if costs become higher, the company might decide to postpone the investment. Increased interest payments can also put pressure on profits.However, not all companies’ interest payments increase the moment interest rates rise. For portions already borrowed at fixed rates, the terms may not change during the contract period. The impact also differs between companies with high debt and those with low debt. Interest rate changes can also affect household mortgages and the like, which in turn affects corporate sales through consumption, but this is something that happens over time.There is another major channel for stock prices. People who buy stocks think about how much a company will earn in the future and how much of those results can be delivered to shareholders. How much is that “future money” worth today? Interest rates are involved here as well.Let’s assume you can definitely receive 1 million yen one year from now. To think about it in terms of today’s money, if you discount it at 1% per year, the value is about 990,000 yen. At 5% per year, it is about 950,000 yen. Even if the amount received is the same, the higher the yield used for comparison, the lower the current value. This is the concept of “discounting.”The yield used in this calculation is called the discount rate. Here, 1% and 5% were just hypothetical figures. Future profits from stocks are not a guaranteed 1 million yen. Profits can increase or decrease, and the return for that uncertainty is also involved when considering the discount rate. Interest rates are one component of the discount rate, but you cannot calculate the decline in stock prices simply from the extent of the interest rate hike.Even so, if the benchmark for converting future money into current value rises, the stock price that investors are willing to pay for the same profit forecast tends to be lower. This is one of the reasons why rising interest rates weigh on stocks.There is also a comparison with deposits and bonds. If the expected yield on newly purchased government bonds rises, investors will rethink, “What kind of profit can I expect from risky stocks?” This does not mean that everyone will sell stocks and buy bonds all at once. It is a comparison of expectations for future profits against the risks taken. The benchmark for that comparison changes.Reading this far, it might still seem like “rising interest rates = lower stock prices.” However, it is not just interest rates that move stock prices. The reason why interest rates rose is also important. If interest rates rise because the economy is strong and there is a view that corporate sales and profits will increase, the expectations for profit may outweigh the burden of interest rates, and stock prices may rise. On the other hand, in a situation where vigilance against inflation is intensifying and corporate costs are also likely to increase, both profit prospects and interest rates can be a burden on stocks.One must also be careful about price movements on the day of an announcement. If a central bank’s interest rate hike was anticipated beforehand, that possibility might already be priced into the stock market. What causes the market to react after an announcement is not just the fact that a rate hike occurred, but what was different from expectations and how the outlook for future interest rates was revised. A day where “stocks rose despite a rate hike” cannot be called a contradiction based on that fact alone.When connecting interest rates and stocks, I would first like to confirm what interest rate rose and why. Next, have the profit prospects for companies become stronger or weaker? What kind of companies or industries moved? Even with the same interest rate hike, looking at these factors reveals a different landscape.Rising interest rates affect how companies use money and the price investors place on future profits. That is the reason why it is said that “stocks tend to fall.” However, the result changes depending on the background of the interest rate movement and the profit outlook. Rather than jumping to conclusions with a single arrow, tracing what happened along the way is the perspective I want to continue using in this world map.Next time, “What exactly are bonds?” We will look at government bonds and corporate bonds, which have appeared many times in interest rate news, starting from the basics.Reference MaterialsBank of Japan: “How does monetary policy affect the economy and prices?”Federal Reserve Board: “Financial Stability Report: Asset Valuations”Federal Reserve Board: “Pre-Announcement Effects, News, and Volatility: Monetary Policy and the Stock Market”DisclaimerThe content of this article and this account is intended to provide information for learning about finance, economics, and market mechanisms. It does not recommend the purchase or sale of specific financial products and does not provide investment advice. It does not guarantee future market trends or investment results. Please make investment decisions at your own responsibility.Outsider Trading Researchhttps://note.com/outsider_trThis is a note run by my investment mentor.They are also my benefactor who gave me the opportunity to start investing and learn about stocks. Not only did they teach me about investment knowledge, but they also taught me various things about how to face the market, how to think about trading, and what to do when I was worried about life.Much of what I will be writing in this note from now on, and the thinking at its root, is what I have learned from my mentor.If you have read “World Observation for Stocks” and liked it, please take a look at my mentor’s note as well.I am sure you will find something new to learn.