How Interest rates affect stock prices – II

This is part II of the article, How Interest rates affect stock prices – Part I. Please read the article from part I before continuing with this one

As I’ve mentioned in my previous article Stock Market Collapse, the rate cut by Fed was expected on 18^th September. My feeling was that either Fed will cut rate by 25 basis points (or 0.25%) on 18^th September and by another 25 basis points in next one month, OR it will go for a straight 50 basis point on 18^th September. The second guess came true (I was lucky). Anyways, the predictions are that a further 25 basis point cut may be required and it may happen anytime within a period of coming next 3 months.

Why did Fed cut the rates?

As I’ve explained in my previous article Sub prime mortgage crisis, the different industries are inter-related. The problems identified in the housing loan markets have hampered not only the real estate stocks world wide, but also the different related sectors of Banking, finance, consumer spending and so on. The stock markets in US and around the world took a nose-dive due to the subprime mortgage crisis. Investors lost confidence in stocks and they started taking out the money from stock investments and put it in bank account or interest rate based bonds.

The Fed want to restore the confidence in stock market and also give a positive signal to the investors that the regulatory authorities are not sitting idle. They are taking appropriate action as and when the situation demands. That is the reason that a rate cut by Fed has been welcomed by the investors with a big positive swing in the stock market.

In India, RBI is also expected to go for a rate cut, but not very soon. It may cut the rates sometimes within a period of 4 to 6 months. Well, that’s a long period and situation can change drastically.

So what’s in it for the investors like you and us? If you understand economic factors and finance, you may take a bet in the stock market in the expectation of something to happen. Like I made a guess about the rate cut, it came true (just by luck) an I am now in profit in my ETF investments. However, as explained in my previous article Stock Market Working, anything that is expected is already reflected in the stock prices. So, when you an I make such a guess and invest on that basis, we are doing nothing better than making a bet.

Choice is yours, depending upon you calculations and confidence, you can take a bet :- )

I believe this article should inform you about the relation between interest rates and stock prices. Have nay questions, post in the comments.

You may be interested in reading my previous articles. Here is the link to Table of Contents in a chronological order.