How Do Interest Rates Affect Stock Prices?
Warren Buffett explains
The relationship between bonds and interest rates is well understood: When prevailing interest rates rise, bond prices generally drop. That’s because newly-issued bonds will carry higher rates and thus be more valuable to investors than older bonds with lower rates.
But interest rates also affect the value of stocks. Warren Buffett explains why:
“A stock is the same sort of thing [as a bond]; it has a bunch of coupons. It’s just they haven’t printed the numbers on them yet…The value of this equity bond that in effect you’re buying you are buying when you buy it…you are buying something that over time is going to return cash to him…and those are the coupons.”
(See the full video below.)
The relationship between interest rates and stock prices, in other words, is the same as the relationship between interest rates and bond prices. The only difference is that stocks don’t carry explicit coupon payments in the way that bonds do. But all things being equal, rising interest rates will cause stock prices to fall, and falling interest rate will cause stock prices to rise.
In 2022, when both stock and bond prices both dropped simultaneously, it was precisely for this reason—because the Federal Reserve had raised interest rates so significantly and so quickly.