Moonlight23
2022-11-05

As long as the Feds continue raising the interest rates, the stock market will continue to underperform. Here's why.

The key understanding here is that interest rates = cost of borrowing. Many reasons why one might borrow money. Businesses require capital to generate more capital. Individuals need to borrow funds for hire purchase items/large value items. Governments need to borrow in order to finance infrastructural maintenance. All in all, a large part of the economy operates on borrowed money. 

What happens then when interest rate rises? Borrowing cost go up. And as with everything, the more expensive something is, the less one would purchase of it. In this case, this leads to less borrowing on the side of businesses, individuals and governments, as well as the incentivasation to save in order to capitalize on the high interest rates. All in all, this leads to a shrinking economy.

Shrinking economies have proven to be bad for stock markets in general. As the stock market is a reflection of the value of businesses (assuming perfect information), as producers cut back on production, and consumers (individuals and governments) cut back on spending (which leads to even less capital inflow into businesses), the value of businesses drops. The stock market thus will drop in tandem with the rising interest rates.

Tldr, the only way for the stock market to sustain this rally is for the interest rates to go down/decrease it's pace of increase. For that to happen, inflation has to fall enough to convince the feds that such high interest rates are no longer needed. It might be prudent to address the supply side reasons as to why inflation is increasing instead of targeting the demand side with contractionary monetary policies, which might, in the long run, do more harm than good. 

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