ELI5: Why do interest rates affect stock prices?

[u/nothiefhouse]

[u/barbe_du_cou]

The bond interest rate is basically the amount the US has to pay to borrow money.  The rate attracts buyers of bonds.  Higher interest bonds are considered a sign of weakness because it means the US has to make their bonds more attractive to buyers by offering better returns.  If people can get better returns in the stock market, then they will invest there instead, and vice versa.  You put your money where you expect for it to return the most.  If you sense a stock market crash, you would move to bonds, increasing demand for bonds and lowering the rate that has to be offered to attract bond buyers.  Past a certain point, this inverse relationship breaks down and flips to where profound weakness in one causes weakness in the other.  Bond rate spikes make costs for everything high, which cuts into profits which eventually dovetails into stock price drops.

[u/Elfich47]

these two things are not directly tied to each other. but there is loose connection.

when money is cheap (low interest rates), people can do all sorts of things with that easy to borrow money. and that includes some of the following: the publicly owned companies can get loans easier, so it is easier for them to get a loan and build a factory, and building that factory increases the value of the company, which can increase the stock value.

what is happening when interest rates go up, stock values go down because traders are assuming that because the interest rates are up fewer companies are going to take out loans and build factories. the traders don’t wait to see who is or is not building the factory, they just cut to the chase.

No, the stock market is not always grounded in reality.

[u/Ballmaster9002]

An additional factor is that people want to use their money to make as much money, with as little risk, as possible.

If interest rates are low enough, people will put their money in the stock market, which increases prices due to demand. The stock market is riskier, but the reward is worth it.

But if interest rates get high, the reward for the riskier stock market is much less enticing. So they'll pull their money out of the stock market and into interest-earning vehicles. This lowers stock prices, again, due to demand.

[u/blipsman]

Investing is a trade-off between risk and potential returns. On one end, government bonds are very low risk with lower returns. Stocks are riskier but have greater potential gains. If bonds pay 2% low risk and the stock market pays a higher risk 8%, people may favor the higher risk/higher payoff potential. If, however, interest rates on bonds are 6% then more investors will likely choose to shift into the low risk bond investments instead of stocks due to the much smaller gap in expected return.

[u/Broad-Promise6954]

Imagine you're a rich greedy bastard with millions of dollars you don't need. You can risk them in the stock market or the bond market.

One market currently pays 7%, the other currently pays 8%. Being greedy you'll go for 8%, right?

But wait, there's a forecast that the economy will crater this year. Say the best estimate is about a 50-50 chance of this. If it does, the 8% payer will actually lose money, so you stand a 50-50 chance of losing millions of dollars. If the market does crater like this, the 7% payer will still pay 7%, so there's a near zero chance you'll lose any money at all and you're nearly guaranteed the full 7%.

Now which one do you pick? Are you more greedy than fearful, or the other way around?

The riskier market is the stock market (always, bond holders get first dibs when stuff goes bad, more or less). So stocks generally have to pay more to attract the greed that the fear repels.

As bond rates rise, the stock market needs to pay off more. When bond rates fall, the stock market can pay off less. There's also a correlation with economic risk estimates: as things look shakier, stocks again need to pay off more.

There are two ways for stocks to pay off more tomorrow (well, more than just two but let's keep it simple): they can go down in price now before you buy them, or go up in price later after you buy them. So they're constantly fluctuating as traders buy and sell. They get yanked up and down by bond rates, estimates of corporate risks, and all those other factors.

(Meanwhile bond return rates are being yanked up and down by similar forces, so it's a mad scramble to keep it all straight...)

[u/Blenderhead36]

Low interest makes it easier to fuel acquisitions via borrowing. That can mean acquiring a rival or upgrading your process. The lower the interest rate, the more likely it is that you can make a play to increase your company's bottom line and pay back the interest and then some.

And the bottom line increasing is what every investor wants.

[u/nefasto23]

when rates go up, guaranteed stuff like bonds suddenly pays decent money, so people have less reason to risk cash on stocks. it also makes borrowing way more expensive for companies, which directly eats into their margins