How Rising Interest Impacts Equity Markets

As interest rates rise, the impact on equity markets is inevitable. The question is, what will the effect be?

It’s generally believed that rising interest rates are a sign of a strengthening economy. With the rapid inflation we’ve seen over the past two years, rising rates are necessary to slow inflation. However, as many sectors adjust to increased interest rates, investors should be aware of the impacts to make sound investment choices. 

Why are rates rising?

During the COVID-19 pandemic, banks reduced rates to stimulate the economy and encourage spending. At this time, rising interest rates are in response to rapid inflation and economic growth. When we see rising interest rates, there is more concern about inflation than employment or job creation. The economy is strong and getting stronger. There are many jobs, so the current focus is to slow inflation. Often low interest rates allude to a weak economy, and rising rates mean a strengthening economy.

The record low rates we saw throughout 2020 and 2021 meant that necessary supplies couldn’t meet the demand, leading to record growth in inflation and creating many jobs to try to keep up. Rates must increase to curb the rampant inflation rate and level out the economy.

How do these rates impact equity markets?

Interest rates rise and impact a company’s earnings and future profits. Rising interest rates mean it’s more expensive for these companies to borrow money. Due to the increased borrowing cost, many companies will cut back on spending and growth tactics which will lower their estimated future profits and, in turn, the stock prices. Investors who already held stock may be unimpressed with the lower returns. As more of the company’s money goes into paying interest, it takes away from dividends and capital paid to shareholders. These investors may also be unwilling to sell their shares at a reduced rate when the cost of the shares lowers.

Some sectors within the equity market will be more heavily impacted. These companies are generally debt-heavy companies. When interest rates are higher, the future profits are less valuable. Increased interest rates can significantly impact companies and sectors that rely on the promise of the future, such as tech, new, and growing companies. 

In addition to rising interest rates’ impact on loans, consumers will also begin to slow their spending for a time as interest rates increase. This reduced spending also negatively impacts the profits of publicly traded companies. 

It’s not all bad news.

Rising interest rates are necessary to slow the rate of inflation. Not all sectors will be negatively impacted by a rise in rates. Investors should consider this as they plan their strategies for the next few years. For example, financial industry sectors will see growth and investing in these sectors could be wise. 

Real estate is one industry that will see the impacts of rising interest rates. Houses are already sitting on the market for longer and bidding wars are cooling off. There is a way to use this to your advantage when investing. With a mortgage pool, you’re on the right end of an increase in interest rates. You gain earnings when the borrowers pay their loan plus interest back. The higher the interest, the greater your growth potential. 

Curious about how you can reap the rewards of a strong economy and increased interest rates in your investments? Get in touch with Jordan on our team to learn more about how to be on the right side of a rate increase in the real estate market.

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