How Interest Rates affect the Prices of Stocks

Q. Do interest rates affect the prices of stocks?

Surely it can't be a personal investor, is it some sort of balancing act?

A: In a word - Yes! If interest rates rise the value of all other investments are likely to fall as people are not prepared to pay a lot of money for an asset that cannot yield what a risk free investment could. The higher the interest rates, the greater the depressing effect on all share prices because the rates of return that investors need from any kind of investment are directly tied to the risk-free rate they can earn. Conversely, if interest rates fall, the move pushes the prices of all other investments upward.

Over the last few years interest rates have fallen to historically low levels and this gave a boost to stock prices, however since that low point interest rates have started to rise and look set to rise even further which is likely to have a depressing affect on stock prices.

Q. Why is that dropping interest-rates doesn't always work?

Surely it can't be a personal investor, is it some sort of balancing act?

A: One of the reasons that John Maynard Keynes recommended direct government intervention in the economy is that sometimes you reached a point where cutting interest rates was like 'pushing on a string.' And we're already past that point.

In normal times, cutting interest rates encourages extra borrowing because it allows people to borrow more money. But that assumes that people want to borrow. Now that the housing bubble has popped, demand for loans has slumped. Not only are people unwilling to borrow money to buy a depreciating asset, but those who own a house are stuck with the uncomfortable realisation that the 'wealth' they thought they had stored in their house is declining by the day. That doesn't put you in the mood to spend.

So regardless of how low you drop rates, people don't want to borrow more. They want to pay back their debts. Meanwhile, lower rates also punish savers, making them feel insecure about their net worth, which encourages them to hang onto their cash rather than spending it.

You see, dropping interest rates is NOT the right policy. Why not? Because, and I would have thought it was obvious....the normal impact of falling rates is that people borrow more to buy, um, cars and houses. But that's not going to happen IS IT because housing is in freefall (-2.2% month on month). And who is feeling rich enough to buy a new car? So they can drop away, helping home owners (back to where they were) but shafting result zero if we're lucky. And if all that seems like nonsense then just look at Japan. I swear, we need someone to step up to the plate who can sort out this mess...coz we're in big trouble if that doesn't happen.

If you don't believe this, then just look at Japan. How successful was the zero interest-rate policy and massive government spending there? If 19 years of economic stagnation is your idea of fun, then yes, it worked very well. But most people would rather avoid that outcome.

The Spending Bubble...

You rush out and buy a television for £1000. John Lewis puts the money in the bank and the bank keep £100 and lend out £900 to a sucker who wants a television but who doesn't have the cash. The sucker runs to John Lewis and buys a television for £1000. John Lewis bank the £1000. The bank keeps £100 and lends out £900 to the next sucker who can't afford a television. Do you see?

The bank has £200, has lent out £1800, John Lewis has £2000 and two televisions have been sold. Two people owe £1800 + interest, which makes the banks richer so they can lend out more money. Do you see how spending creates money? We started with just £1000! They're just creating another bubble to get us out of trouble!

It's bonkers coz we're using a bust model to solve the problem but nobody has any better ideas right now. Spend spend's as simple as that!

 ...Continues here - What are your thoughts on Free Trading Seminars?

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