Is there a connection between interest rates and the stock market?

Q:   What do interest rates have to do with the stock market?

A:   That’s a great question, and the answer is: more than you think. There are two main relationships — first the competition for your investment choices, and second the effect that interest rates have on the companies that issue stocks.

Regarding the competition issue, imagine that interest on intermediate length bonds pay 8% a year (and assuming inflation is low). Long-term stock returns are around the same return, but the returns are much more volatile. 

Is there a connection between interest rates and the stock market?

So, why buy stocks when you can get a similar return with stable fixed income investments? A second competition for your investing dollar is the effect that higher interest rates would have on what you spend your money on besides investments. As interest rates rise individual investors might have less money to spend on stock investments-their mortgage and car loans cost more and disposable income drops. The reverse is also true — dropping and lower interest rates means that stocks are more attractive than bonds, and result in many families having more disposable income with which to invest.

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