Interest rates have long been regarded as an important indicator of a nation’s economic health. Here in the U.S., interest rates have been climbing higher, which has an impact on everything from consumer spending to mortgages.
Naturally, this leaves investors concerned about the stock interest rate. How do interest rates affect stocks? This article will explore this question and provide some input on stock trading during this unusual economic period.
Why Is the Interest Rate Rising?
In the United States, interest rates are set by the Federal Reserve. More specifically, interest rates are governed by the Fed’s policy arm, the Federal Open Market Committee (FOMC).
Why would the Fed deliberately choose to raise the interest rate? At present, the goal is to raise interest rates in order to fight soaring inflation. According to Edmund S. Phelps, winner of the 2006 Nobel prize in economics, this helps restore the balance between supply and demand.
“You can look at our situation as aggregate demand exceeding supply, and that’s causing prices to rise,” he tells the New York Times. A rise in interest rates will “clamp down on demand” by raising the cost of borrowing money.
But that has others concerned about the cost-benefit outcomes of continuing to raise interest rates still higher. As of June 2022, the Federal Reserve raised interest rates by another 0.75%, the largest hike since 1994.
How Interest Rate Affects Stocks
There’s no question that rising interest rates impact American consumers. Banks pay more to borrow money, and these higher costs are passed on to individuals and businesses in the form of higher interest payments.
The mortgage industry, in particular, has been impacted by rising interest rates, though consumers are also seeing higher rates on other long-term loans such as those used for cars.
But what is the interest rate effect on stocks? The connection isn’t a direct one, to be clear, but the effects of stock market interest rates can be directly felt by consumers and investors alike.
While smaller consumer goods are not immediately affected by the interest rate, the stock market is. When interest rates rise, it limits the average consumer’s ability to spend money. In short, they buy less, which translates into less revenue for American businesses.
Less revenue means lower overall performance. So when you look at the stock market, interest rates have an indirect but measurable effect. When interest rates rise, the stock market tends to perform poorly. When interest rates fall, the stock market tends to perform favorably.
When Will the Stock Interest Rate Drop?
What goes up must come down, right? Higher interest rates can have long-term consequences for the American economy and decrease the spending power of the average consumer.
In light of recent hikes, it’s not clear that the Fed will reduce interest rates until inflation begins to decrease. Thankfully, there’s some light at the end of the tunnel. According to Preston Caldwell, head of U.S. economics at Morningstar, Americans can expect to see inflation rates normalize between 2023 and 2025.
It’s reasonable to expect inflation rates to stabilize at around this same time. Already, Americans are seeing a dip in gas prices, which may be the first of many signs that the economy is stabilizing, if not recovering.
The downside is that until that day comes, the stock interest rate will have a negative impact on current and prospective investors. Still, that doesn’t mean that investors should avoid investing altogether, though they should adjust their strategies to match the present economy.
Investing Strategies in the Present Economy
Investors can’t afford to ignore the stock interest rate, but they don’t have to sit dormant until things stabilize. The best way to invest during a period of recession or uncertainty is to follow a few basic guidelines.
Pick Stable Sectors
Some companies will perform well regardless of the larger economy. These include those in industries that aren’t as strongly impacted by inflation rates but can also include consumer staples stocks that aren’t as dramatically impacted by economic shifts. You might also consider industries such as:
- Insurance and healthcare
- Telecommunications
- Energy
- Finance and real estate
In some cases, you may be able to find mutual funds or exchange-traded funds (ETFs) that track these sectors, making it easier to develop a portfolio.
Focus on the Big Names
Large-cap stocks offer greater stability during an economic downturn. While the stock inflation rate can diminish the performance of these industry giants, that can also provide investors an opportunity to snatch shares of big-name stocks at historically low prices.
These large companies aren’t immune to inflation rates and consumer spending patterns, but they have the stability to weather periods of economic recession and can even provide some stability if your portfolio contains smaller, riskier startup investments.
Take Advantage of Financial Companies
As interest rates rise, financial companies and lending institutions will reap greater profits from their borrowers. This reality means that even while other industries are struggling, banks, credit bureaus, and other financial institutions remain profitable.
Therefore, it only makes sense to sink some of your investment into banks or other financial service providers. Rising interest rates will therefore boost your portfolio, and even after rates stabilize, many of these corporate giants remain valuable buy-and-hold stocks.
The Best Stocks for Rising Interest Rates
Given the rising interest rate, trading might seem risky. But the interest rate can be a benefit to financial institutions and those in the lending industry. Here are some of the best stocks to invest in while interest rates climb:
AllianceBernstein (AB)
Financial companies like AllianceBernstein are weathering interest rate hikes quite well. With increased volatility, many investors are shopping around for the best opportunities and AB has one of the best-in-class fixed income divisions that can help investors understand the current landscape.
Discover Financial Services (DFS)
Founded in the 1960s, Discover Financial Services has risen to compete with Visa and American Express, providing lending opportunities as well as a digital banking division. With rising interest rates, institutions like DFS stand to cash in on loan repayments, making this a solid choice as rates continue to climb.
Equifax (EFX)
Equifax is best known for providing consumer credit scores, making this a household name in the consumer lending industry. While America’s attention has been on the movements of the Fed, Equifax has been quietly executing a series of acquisitions that only solidified its place as a leading credit and analytics company.
Navient (NAVI)
Admittedly, some investors may have qualms about profiting from the student loan industry. Nevertheless, there’s money to be made, and rising inflation rates only maximize this opportunity.
Navient is a leading provider of student loan services, and as students continue to enroll in expensive college programs, revenues are expected to continue regardless of the larger American economy.
Bank of America (BAC)
Alongside peers like Wells Fargo and Citigroup, Bank of America stands to benefit from an interest rate hike. Rising interest rates mean that the bank will bring in more money for the loans it provides, and this increased revenue translates into greater shareholder profits.
Palo Alto Networks (PANW)
Inflation rates aren’t the only thing rising at the moment. As geopolitical tensions mount, there’s been an increased demand for cybersecurity services, giving Palo Alto a competitive edge both domestically as well as around the globe.
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