We have returned to a time where interest rates and inflation will be a major factor in stock market performance. It wasn’t too long ago where we were all waiting on the latest Fed interest rate decisions. We have returned to that same place once again. The Fed is not expected to make any significant changes in the near term to interest rate policy, but the recent increases in the rate of inflation point to some important Fed decisions in the next few months.
Inflation Impact on Interest Rates
When inflation spikes like it did in 2022, interest rates would typically increase so that lenders can get a rate of return on their money that exceeds inflation. In addition, the Federal Reserve raises interest rates to attempt to slow down economic activity. The Fed believes that the slowdown in economic activity (demand) will stop prices from rising. Their strategy worked well in 2022 and 2023 as inflation and interest rates decreased without sending the economy into a recession.
Unfortunately, after several years of progress, inflation and interest rates are climbing once again. The Fed target of 2% inflation was never reached. Inflation was trending down nicely, but the trend was interrupted by tariff increases in 2025 and now by the war in Iran.
Prior to the war in Iran, most people were expecting interest rate decreases from the Fed in 2026. With inflation on the rise once again due to oil price increases, expectations for rate cuts in 2026 have disappeared. The new Fed chair, however, has a mandate to lower interest rates. It will be interesting to see how that plays out.
Interest Rates and the Stock Market
Interest rates have a pretty significant impact on the stock market. Changes in interest rates often lead to changes in stock prices particularly when interest rates increase.
Let’s look at why that happens.
One reason for this is the competition among investment assets. With only so many investment dollars to go around, money invested in bonds (interest bearing assets) represents money that is not invested in stocks. When interest rates on bonds increase, they become more attractive investments relative to stocks. When funds move from the stock market to the bond market, stock prices tend to decrease.
The same thing happens in reverse. If interest rates on bonds are very low, investors are drawn to the potential for higher returns in stocks. Many people think that the rapid rise in stock prices between 2010 and 2021 was partially driven by the extremely low interest rates during that time. In the previous decade, interest rates were often close to zero. Investors were almost forced into owning stocks as bonds became much less attractive.
In the 1970s, inflation and interest rates were at extremely high levels. Bonds were earning as much as 15% per year and people were taking on mortgages with interest rates in the mid-teens. Money moved out of the stock market and into the bond market in the 1970s. As a result, the stock market dropped significantly in the mid 1970s.
In 2026, inflation is increasing once again. Inflation had fallen to about 2.5% previously. It reached 3.5% in April and May came in at 4.2%.
Interest rates on 10-year Treasury notes were under 2% at the beginning of 2022. They are now sitting at about 4.5%. It was sitting at just under 4% in the last six months until oil prices increased dramatically this year. The 10-year Treasury yield is important because it affects mortgage rates, car loans and commercial loans.
There is another important reason why interest rates affect stock prices. Unfortunately, it is a little complex to describe. Investors value stocks based on the projected cash flows of the businesses they represent. Future cash flows are discounted based on current long term interest rates. When interest rates are higher, the future cash flows are discounted more. Therefore, when interest rates rise, the financial value of every company’s cash flow decreases. Stock prices decline as a result.
Since technology and high growth companies have higher projected future cash flows, their stocks decrease more than other companies when interest rates increase. This is why the Nasdaq and technology stocks lost more value in 2022 compared to the S&P 500. The Nasdaq dropped 30% in 2022 while the S&P 500 dropped by 20%.
This is one of the reasons why tech stocks have fallen more than the S&P 500 recently. As I write this post on Wednesday, June 10th, the Nasdaq (tech/growth) has dropped about 6.5% in the last week compared to a 4% decline for the S&P 500.
CONCLUSION
The main thing you need to know from all of this is that rising interest rates are bad for stock prices and declining interest rates are generally positive for stock prices. You also need to be aware that higher growth technology stocks are more affected than slower growing stocks.
If you are an aggressive growth investor, keep an eye on inflation and interest rates going forward. My historical analysis indicates that 6% inflation is a key level. Stocks typically hold up pretty well until the inflation rate climbs over 6%. Markets tend not to react too much when inflation is running at 4.2% like it is currently. Expectations of future inflation can play an important role, however.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
The trend in stock prices has continued upward over the last month. After the decline in March, the S&P 500 has climbed 17% and the Nasdaq has climbed 26%.
All the major market indices reached new all-time highs last Thursday the 14th and are still hovering near those levels. Stocks have fallen slightly over the last week.
At the beginning of April, Wall Street began to look past the situation in the Middle East. Even though the Strait of Hormuz is still closed, the market is expecting it to open very soon. Oil prices remain high, but the expectation is that they will fall rapidly once the Strait is reopened.
When we look at the wider trend since last October, we were stuck in a flat cycle until early March. It then looked like the trend broke in a downward move – only to be reversed by the latest move higher in April. The tech sector (see Nasdaq in the graph) has been leading the recent increase in stock prices.
I expect continued volatility until ships can traverse the Strait freely. The stock market does not care about the war, only the movement of oil and other products through the Strait.
The Middle East risks still boil down to the price of oil and its impact on inflation and interest rates. If the commodity supply issues continue, the potential for a bigger impact on the economy increases.
Oil is hovering around $100 per barrel – down from the peak of $115 but still 80% higher than it was in January. Interest rates are up about 10% this year but still in the same range they have been in the last three years.
Bullishness about corporate earnings is driving the stock market higher. Corporate earnings saw above average increases last year and the market is expecting even higher profit growth in 2026.
Tech stocks have led the recent stock market rally. Semiconductor stocks are up 50% this year – a huge move in a short period of time.
The expected interest rate adjustments from the Fed have changed significantly in the last three months. Previously, the market was expecting one or two rate cuts this year from the Fed. Due to inflationary pressures, the market is now expecting one or two rate increases.
SUMMARY
This is an unusual time in the financial markets. There are some extremely positive data points – very high corporate profit growth, AI advancements, massive spending on AI infrastructure, and strong consumer spending for affluent consumers. We also have some very negative factors to consider – high energy prices, rising inflation, rising interest rates, strained middle class consumers, no help from the Fed, and increasing risks of recession.
The negative forces are all tied to the Strait of Hormuz. This is why conflicting and changing news reports regarding the Iran situation are distorting market forces more than usual.
Rather than pay attention to the questionable news reports, it makes more sense at this point to pay attention to the price of oil and the direction of interest rates.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
Recent patterns in the stock market are eerily similar to what happened in the late 1990’s during the dot-com bubble. Look at this chart comparing the price movements for the Nasdaq in the last few years to the period from 1995 thru early 1998.
In both cases (1990s and now), the Nasdaq increased by about 150% in just a little over three years. The similarity is pretty amazing, right?
Let’s now look at what happened to the Nasdaq in the 1990s in the subsequent two years.
The Nasdaq grew by another 150% in the two years from early 1998 to early 2000 – bringing the five-year total increase to almost 600%. The price of the Nasdaq index increased from 743.6 at the beginning of 1995 to 5,048.6 in March of 2000 – a sevenfold increase.
We all know what happened next. The Nasdaq dropped by almost 80% over the next 2.5 years – bottoming in late 2002. It took until 2015 for the Nasdaq to recover its losses.
The question of everyone’s minds right now is “What happens next in this market”?
KEY DIFFERENCES NOW vs. THEN
The late 1990s period was a true bubble.
Prices rose solely based on the promise of the future of the internet.
Every dot-com stock was bid up to stratospheric heights.
The price gains were NOT driven by profit growth. Profit growth in the late 1990s was only average.
The current period is being supported by exceptional profit growth.
Corporate profit as measured by the S&P 500 grew at twice the normal rate in 2025 – mid-teens vs. the typical 8%.
First quarter 2026 estimates for profit growth are expected to be 27% - three times the typical growth.
Profit growth is being driven by the tech companies – their profit growth is much higher than 27%.
PROFITS DRIVE STOCK PRICES
In the long run, stock price increases follow along with increases in earnings. The stock market is rational in the long term.
Most stock market valuation models (including mine) relate stock prices to earnings – the Price to Earnings ratio or multiple.
Historically, the price of the S&P 500 index has averaged around 19 times earnings.
When industry experts see the P/E multiple of the S&P 500 at a figure of 25 or higher, that is when you hear talk of the market being overvalued.
But if earnings are growing at 20% per year, the math changes dramatically. The typical P/E ratio of 19 corresponds to profit growth of roughly 8% per year. People will pay much more for stocks whose profits are increasing by 20% per year vs. 8% per year.
The S&P 500 index was at 5,942 at the beginning of January of 2025. If it was fairly valued at the start of 2025 (a big question), and profits grew by 15% we would have expected to see the price rise by 15% to 6,833. The S&P 500 finished 2025 at around 6,920. In that context, the market doesn’t seem so overvalued.
If S&P profits grow by 27% in 2026, it would not be out of the question for the S&P 500 to reach 8,671 by the end of the year. The current price is 7,505. Again, not so unreasonable.
Don’t get me wrong. I am not saying that the S&P 500 is undervalued right now. The final profit numbers are not even in for 2025, and the 2026 numbers are only estimates. Also, two data points to not make a trend. Profit numbers do tend to bounce around.
What I am saying is that the current bull market cycle is very different than the one in the late 1990s.
In the 1990s, there was a tremendous amount of hype and promise around the internet. Now, we are seeing the same thing around AI. Reality hit in the early 2000s when sales and profits did not live up to the dot-com hype.
There will be some disappointments in the next couple of years related to the promise of AI. Many of the massive investments being made now to support the growth of AI will not pay off. Some will, though. The stock market will take some hits as reality settles on AI.
But, when profits are growing at two to three times the normal rate, stock prices should rise significantly.
AI is already producing some large productivity gains in many sectors of the economy, and those gains should accelerate over time.
WHAT HAPPENS NEXT?
Whether a particular market cycle is a bubble or a more typical bull market, the biggest gains always happen at the very end of the cycle. This is simply the emotional reaction of investors who fear that they are missing out and more evidence of the typical herd mentality of the stock market.
Rapid run-ups like this recent trend do lead to corrections as the market needs to take a breather periodically. But if profits keep growing at the current rate, those corrections will be short lived.
My main point is that we are not at scary or irrational levels in the overall stock market. In 1999, there was no justification for the crazy growth in the Nasdaq and the S&P 500. It was all hype.
Keep your eyes on what really matters – profits.
I will keep my investors situated aggressively in stocks if the trends support it. If and when the trend changes, we will adjust accordingly. We will follow a data-driven, disciplined process that is not influenced by fear or greed. You should too.
Stay Disciplined My Friends,
Phil
Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.
Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.
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