The stock market definitely won’t benefit from the new tight monetary policy. There is information coming from the Federal Reserve about the time when the policy will be tightened, however, it is not officially stated. But that is not the only risk for the market and its prices. All possible factors starting from the coronavirus and domestic consumption and finishing with some international crises in economics and politics should be considered by investors and stock leaders. But of course, this tight monetary policy will create even more difficulties.
In general, interest rates affect the prices that are generated on a stock market and property values. The higher the interest rates are the worse it is for the stock market prices. And there are 2 reasons for that.
First of all, if the interest rates become higher, it means that present values become lower as well as future earnings. That means that the money that you can get right now is worth more than the same amount that you may get in 1 year. That is why if you have your profits now, it can be more beneficial to invest them for payback. Another idea is repaying a debt to get some interest. Remember that the present value actually means today’s value of future earnings.
The second reason why higher interest rates affect the stock prices negatively is that when the interest rates become higher an economic upswing is slowing down. And it may even lead to the economic crisis. In such a situation, first of all, all interest-sensitive spending (for example, purchasing cars or building new houses and apartments) will be decreased. As a result, all people working in these spheres will struggle because the earnings will be lower and the consumption will be reduced. All of this means the higher interest rates are the lower income of a particular company is if we consider the present value of its future income. According to analysts at Buystocks.co.uk: “It’s going to be the first time in almost two years that the Fed’s incremental decisions might force investors or consumers to become a little more wary”.
But there is also an opposite situation when the stock market can actually grow when interest rates become higher. Generally speaking, interest rates can grow when the economy is strong enough. So when this economy is boosting, all companies and customers start borrowing and spending more money while saving significantly less as a result of which interest rates are growing. That is why it’s impossible to say that high interest rates affect the economy negatively. And of course, when the economy is plummeting, the interest rates are decreasing as well as people start saving more and stop borrowing money.
It is expected and almost obvious that interest rates will grow in 2022. But it’ll happen not because the economy is growing but because the new policy was announced by Federal Reserve. In this case, new interest rates will be not good for companies. Those organizations whose success is interest-sensitive, unfortunately, will face a decreasing number of sales and lower income. And this process will affect many spheres that may be under the influence of interest rates. In general, this new policy can decrease stock prices. It is essential to remember that not only interest rates can affect these prices. For example, the decisions and attitudes of investors are very important as well if we are talking about the short term but it is almost impossible to predict their actions. The stock market prices will depend on the main risk factors but another thing that has a serious influence on them is the current pandemic as it has been one of the main risks for the economy for the last few years.
However, if the economy will still manage to increase its success, then the market won’t plummet despite that negative effect of new policy and low stock prices. The only possible thing that can happen is that the large gains of the last years can turn into less impressive gains. The earnings from bonds are too low right now so it’s hard to believe that many people will prefer fixed income for current bonds instead of what they have now. But at the same time, bonds have a low downside risk which is why it may be really beneficial to hold them even in the tricky times.
But what is the worst situation that can happen to the market? No one can say exactly but everything turned out pretty bad several times in 1939-41, 1973-75, 1999-2002, 2008 periods of time due to different serious issues. It dropped approximately 40% and it’s hard to say if it can be worse this time but if it will be 40% as well then the Standard and Poor’s 500 will come back to May 2019 level. In this case, investors would be able to hold the dividends earned during that time. And it can be considered as a truly impressive argument for stocks.
