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Denis Sergienko • 2022-11-10

Why Stocks Drop When Interest Rates Rise

Why Stocks Drop When Interest Rates Rise

With US Treasury yields growing rapidly, we can see the major US stock markets’ decline. Is it just a coincidence or a regularity?

The net-present value of cash flows is reduced by the growing interest rate following a traditional discounted cash flow model. This fact makes companies with zero or low profitability as well as high debt burdens suffer most of all during the rise of interest rates.

The Different Macro Environment

The macro environment is changing. The times for the majority of risk assets have become tougher featuring the U.S. stock markets down by 30% led by Nasdaq. Some people say the main reason for such a downturn is the misleading strategy on inflation prevention applied by the FED. Others say it is all about geopolitics, the “Russian invasion”, and China’s COVID missteps.

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One can make up dozens of reasons. In reality, a rising interest rate is the only one to blame. It is the macroeconomic fundamental perspective. It does not matter what actually makes the interest rate go higher. The most important question is how it affects traders’ and investors’ interest in different financial markets.

The Federal Reserve Model

Stocks can put bonds at risk as stocks carry additional related risks. For example, if a stock promises a higher expected return compared with bonds, it makes stocks a more appealing investment option. To evaluate the trade potential one can use a so-called FED model that compares S&P 500 earning yields to the US Treasury 10-year yield.

In simpler words, higher US Treasury yields resulted in re-thinking the way people allocate their funds. Bonds and stocks have relatively the same return. The only difference is the risk they bring as well as investors’ risk tolerance.

Long/Short Duration

Any stock refers to the group of so-called long-duration assets. To measure the duration, we need to predict how long it takes to get back the $1 invested. With the increased interest rate, it will take you longer featuring the reduced net present cash value.

So, in times of market uncertainty and soaring rates, you might want to look for a faster way to gain wealth. This is where crypto can be a better alternative promising some good returns in either long or short run depending on your trading strategy. Trade cryptocurrencies with the best platform, enjoy zero spreads, instant withdrawals, and industry-best trading conditions.