INTEREST RATES AND GROWTH STOCKS
- Jun 10
- 4 min read
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
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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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