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Rate Changes & Equity Returns
The positive correlation between rate changes and equity returns this year has been counter-intuitive to many observers. Typically, an increase in rates would lower the value of equities since one would estimate future earnings and “discount” them by dividing by an interest rate that takes into account the time value of money. Higher interest rates also negatively affect corporate profitability by creating tighter credit conditions tighter.
“The reason equities have been positively correlated to rising interest rates recently is because higher rates represent a validation of global growth and are therefore consistent with healthy corporate fundamentals and thus good for stock prices,” Alec Young, managing director of FTSE Russel global markets research team, said in a note. “When inflation is driving interest rates higher it can be more of an equity negative, but lately the interest rate increase has been more about strong US growth and shared international expansion.”
Consequently, the positive correlation between rates and equities this year may be better explained by optimism over global growth.
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