Learning
Why do changes in interest rates move share markets?
Learning
Why do changes in interest rates move share markets?
This article is for general information purposes and not financial advice or a recommendation to take any action.
Interest rates and interest rate expectations play a central role in how investors assess the value of companies – shaping share market performance in Australia and around the world.
When interest rates or rate expectations rise
When central banks lift, or are expected to lift, interest rates - share prices often fall.
This happens because:
Future earnings are worth less today
One valuation methodology used for shares is to discount future earnings back to today, using an interest rate for each future value date (analysts use a ‘discount rate’ which is based on interest rates).
The higher the interest rate – the less a future earning is worth when discounted back to today’s value.
For example a $1m earning in a year discounted at an interest rate of 6% is …. (1m /1.06) = 943,396.23
That same $1m earning in a year discounted at an interest rate of 9% is …. (1m /1.09) = 917,431.19
Companies with profits expected further in the future tend to be affected the most, as there are more years to discount.
Financing costs increase
When interest rates rise, generally, so does the cost of debt.
Companies with debt face higher interest costs, which can squeeze margins and reduce profit.
Investment in growth usually falls
As borrowing becomes more expensive, businesses may scale back or delay investment in growth initiatives, limiting their growth potential for investors.
Investors may shift to stable income assets
When interest rates rise, more stable income options such as term deposits, fixed income and secured credit generally begin to offer higher returns.
Many investors rebalance their portfolios away from stocks in search of this stable higher income.
When interest rates or rate expectations fall
These periods may coincide with stronger share performance – however importantly the outcome also depends on the broader health of the economy.
If the economy is in a healthy state, share markets often increase in value for the inverse reasons to above:
- Future earnings are worth more in today’s value
- Reduced borrowing costs directly positively impact profitability
- Investment in growth agendas, new external investment, and expansion initiatives generally increases – buoying investors
- Investor risk appetite increases – with lower income yields available from term deposits and fixed income, investors may shift toward shares in search of higher potential returns.
How Earnr fits in
Earnr’s products are designed to offer reliable income returns, without capital volatility.
For investors who value income, capital preservation, outcomes, this can offer a welcome alternative.
If you’d like to learn more about how Earnr’s products work as for savings and SMSF strategies, you can reach out to the Earnr team here.
.jpg)
.jpg)
Published
5 October 2023
This article is for general information purposes and not financial advice or a recommendation to take any action.
Interest rates and interest rate expectations play a central role in how investors assess the value of companies – shaping share market performance in Australia and around the world.
When interest rates or rate expectations rise
When central banks lift, or are expected to lift, interest rates - share prices often fall.
This happens because:
Future earnings are worth less today
One valuation methodology used for shares is to discount future earnings back to today, using an interest rate for each future value date (analysts use a ‘discount rate’ which is based on interest rates).
The higher the interest rate – the less a future earning is worth when discounted back to today’s value.
For example a $1m earning in a year discounted at an interest rate of 6% is …. (1m /1.06) = 943,396.23
That same $1m earning in a year discounted at an interest rate of 9% is …. (1m /1.09) = 917,431.19
Companies with profits expected further in the future tend to be affected the most, as there are more years to discount.
Financing costs increase
When interest rates rise, generally, so does the cost of debt.
Companies with debt face higher interest costs, which can squeeze margins and reduce profit.
Investment in growth usually falls
As borrowing becomes more expensive, businesses may scale back or delay investment in growth initiatives, limiting their growth potential for investors.
Investors may shift to stable income assets
When interest rates rise, more stable income options such as term deposits, fixed income and secured credit generally begin to offer higher returns.
Many investors rebalance their portfolios away from stocks in search of this stable higher income.
When interest rates or rate expectations fall
These periods may coincide with stronger share performance – however importantly the outcome also depends on the broader health of the economy.
If the economy is in a healthy state, share markets often increase in value for the inverse reasons to above:
- Future earnings are worth more in today’s value
- Reduced borrowing costs directly positively impact profitability
- Investment in growth agendas, new external investment, and expansion initiatives generally increases – buoying investors
- Investor risk appetite increases – with lower income yields available from term deposits and fixed income, investors may shift toward shares in search of higher potential returns.
How Earnr fits in
Earnr’s products are designed to offer reliable income returns, without capital volatility.
For investors who value income, capital preservation, outcomes, this can offer a welcome alternative.
If you’d like to learn more about how Earnr’s products work as for savings and SMSF strategies, you can reach out to the Earnr team here.
Download the Earnr app and optimise your savings today.
Open your account in minutes through the Earnr app.
