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Politics : Formerly About Applied Materials
AMAT 327.03+2.5%3:59 PM EST
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To: 16yearcycle who wrote (25357)10/16/1998 2:30:00 PM
From: Clarksterh  Read Replies (2) of 70976
 
EK - Interest rates vs stock market:

You are indeed correct that typically there is a strong correlation between lower interest rates and subsequent stock market growth (and vis versa). The primary mechanism is:

1) Economy overheats due to lack of capacity so Fed increases interest rates.

2) Several months later companies start to feel pinch as consumers buy less due to higher rates, and their debt payments increase. They start laying off, and earnings decline. Stock market declines accordingly.

3)Fed sees contraction and lowers interest rates.

4)Due to natural length of recession (time to work off inventory) and and due to lower rates (people start buying again and debt payments go down), company earnings go up. Stocks go up.

However this scenario is completely screwed up since the economy is, atypically, being driven by over capacity not lack of capacity. It may not be possible to create enough demand via lower interest rates to soak up the excess capacity.

Note that there is a secondary mechanism by which interest rates effect stock prices, but it is typically a much shorter cycle. As the interest rates go down, stocks or other investment vehicles look comparitively more attractive than they used to. Thus people become bigger buyers of stocks until they have a valuation consistent with the current interest rates. This mechanism is still in effect, but it typically equalizes out pretty quickly (+330 pts in 1/2 hour). I wouldn't count on it having any further effects over the next 6 months to 1 year.

All JMO. Comments welcome.

Clark
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