What’s the Link between Interest Rates and the Stock Market?

Homeowners who are suffering from mortgage stress may not have had a good night’s sleep last week, given the impending RBA decision on interest rates on the Tuesday. But the good news came with a sigh of relief, as the RBA decided to keep interest rates on hold after 10 straight rises.

What is the effect of interest rates on the stock market?

Rising interest rates can be positive, especially for the stock market, as there is often a correlation between interest rates and how the stock market performs. That said, the direction and strength of the correlation will depend on various factors, which may not always be evident or even consistent.

In general, when interest rates are low, investors tend to chase higher yields, which encourages them to seek higher returns from the stock market in the form of dividends. This increased demand, in turn, can drive up stock prices, especially in some of our bigger stocks paying above average fully franked dividends.

A low interest rate environment also makes it cheaper for companies to borrow money, so they can stimulate business growth, which ultimately increases their stock price. As such, you can see the benefit that a low interest rate environment can have on the stock market.

On the other hand, when interest rates are high, it can make borrowing more expensive for both consumers and businesses and this leads to lower spending and economic activity, which is what the RBA has been hoping for as it tries to rein in inflation. This can negatively impact corporate earnings and lead to a decline in stock prices, although we are not really seeing this in the current environment, which suggests that interest rates are not overly high.

Often the RBA overshoots the mark on interest rates, which is why it becomes a balancing act of not having rates too high to stifle growth, while at the same time keeping inflation in check. Time will tell if they have got the balance right this time.

For investors, it’s important to note that the relationship between interest rates and the stock market is not always straightforward. There are many other factors that can influence stock prices, such as a company’s performance, economic indicators, geopolitical events, and investor sentiment. I think right now the RBA has it right and that we will see good growth in the Australian stock market over the coming year, but again only time will tell.

What were the best and worst performing sectors last week?

The best performing sectors included Healthcare up 3.83 per cent followed by Energy up 2.23 per cent and Consumer Staples up 1.78 per cent. The worst performing sectors included Materials down 2.72 per cent followed by Financials up 1.03 per cent and Consumer Discretionary up 1.45 per cent.

The best performing stocks in the ASX top 100 included Evolution Mining up 8.33 per cent followed by ASX up 7.57 per cent and Northern Star Resources up 7.07 per cent. The worst performing stocks included Allkem down 8.84 per cent followed by Pilbara Minerals down 8.38 per cent and Downer EDI down 5.83 per cent. 

What's next for the Australian stock market?

Two weeks ago, the Australian stock market rose strongly closing higher every day and ending the week up 3.30 per cent. The beginning of last week was very similar with the market rising strongly on Monday. However, given it was a shorter week with Easter, the bulls became more cautious with the market only rising slightly on Tuesday and Wednesday before falling away on Thursday to close last week up just 0.52 per cent.

After eight straight trading days in which the All Ordinaries Index closed higher, it did not surprise me to see Thursday trading down. I expect we may see a couple more down days with lower volumes and volatility as this week is also a short week. The exciting part about what is unfolding is not what the market has achieved in the recent rise, but what it will do in this next week, as this will set the tone for the coming month.

If any move down is short lived in both time and price, then it will signal the bears have gone into hiding. If this is the case, the bulls will push our market higher in the coming four to six weeks with the market likely to rise up to 7,800 points or higher.

As I have continued to say, I recommend investors be patient, as they will be more than rewarded when we get confirmation that the bull market has returned. I suggest investors look at the top 20 stocks on the market, as several look like they are setting themselves up for a nice run, but remember, we need to wait for confirmation that the bull run has returned.

For now good luck and good trading.

Dale Gillham is Chief Analyst at Wealth Within and international bestselling author of How to Beat the Managed Funds by 20%. He is also author of the bestselling and award winning book Accelerate Your Wealth—It’s Your Money, Your Choice, which is available in all good book stores and online at www.wealthwithin.com.au