Author Topic: Relationship between interest rates and share prices  (Read 9651 times)

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Offline Gary Stone

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Relationship between interest rates and share prices
« on: 31/10/2007, 11:33:07 AM »
I had a question from a customer that I thought would be worthwhile sharing my answer to with the Forum.

The question is:
Hi Gary.
Have you looked at any charts that shows the relationship between the above? What prompted me to ask you was the "economic clock theory" that falling share prices are preceded by rising interest rates.



I understand. Let's look at the data.
The attached weekly charts show graph:
1. US 30 day Fed interest rates. This is an inverted graph showing yield - to calculate the yield subtract the chart value from 100. This chart should have 2 decimal points.
2. The S&P500.
3. The rolling 90 day bank bill in Australia. This is an inverted graph showing yield.
4. The ALL-ORDS.
Since 1Q 2003 USA short-term interest rates have risen from around 1% to around 5.25% while the S&P has risen around 75%.
In Australia, short-term interest rates have risen from 4.15% to 7.9% while the ALL-ORDS has risen around 126%.
I suppose in theory the Investment Clock is correct but just WHEN do the rising interest rates cause falling share prices?
These graphs cover 4.75 years. Should we have battened down the hatches as soon as interest rates started rising? Or after 2 years of rising interest rates? Maybe 3 or 4? Is now the time?
There are always more variables (more than single of even groups of human beings can comprehend at any given time) at play in the markets and, yes, there are many relationships that could be analysed on a regular basis.
Hence, the philosophy that we follow is that when the permutation of the all variables that are at play in the equity markets cause market prices to fall, we will react with our time proven and researched strategies rather than try to predict what affect a subset of variables may have in advance. Similarly for rising prices. Hence, our philosophy is that it all comes down to price action in the term that we trade because price action plots the net outcome of all the variables that interact on the markets.
I trust that this answers your question.

On the journey