(Revised 1) Rising Interest Rates and Stock Market

The S&P 500 set an all time record as of yesterday, Janurary 14th, reaching a high of 1848.38 barely beating the previous high by .02 from Dec 31st. (http://online.wsj.com/news/articles/SB10001424052702304419104579322302381985992?mod=WSJ_Markets_LEFTTopStories&mg=reno64-wsj&url=http%3A%2F%2Fonline.wsj.com%2Farticle%2FSB10001424052702304419104579322302381985992.html%3Fmod%3DWSJ_Markets_LEFTTopStories) Both other key performance indicators, the Dow Jones Industrial Average and the Nasdaq Composite Index were also on the up and up. The market has finally rebounded to pre-recession levels, and the S&P grew almost 30% in 2013 alone. Of the biggest winners in the market were the tech companies, including Apple.

Although the stock market is in such great shape, some still worry that an artificial bubble has been created from the Feds quantitative easing strategy. The Fed has announced that they plan plan on backing off the quantitative easing strategy and allowing interest rates to rise. With the Fed ending its quantitative easing strategy will the stock markets artificial bubble come to an end?

A little background on the Feds strategy and how it effects the stock market. After the great recession of 2009 the government looked for ways to stimulate the economy. The Fed came out with the strategy of quantitative reasoning, where they would buy up bonds and keep the interest rates artificially low, targeting about 1 point above the federal funds rate. With low interest rates and more money circulating, consumers were able to spend more, hence stimulating the economy. The stock market grows in two ways from the low interest rates. With interest rates rising, it is speculated that people may avoid making bigger purchases which could end the “artificial” bubble the FED has created.

The first reason the stock market grows with low interest rate, is it is viewed as more favorable than federal bonds. As stocks are more favorable than bonds, the demand grows and the prices continue to increase. The other reason stock prices soar is because of market speculation. When analysts see low interest rates they speculate that the consumers will spend more on big ticket items, and take out loans to finance these purchases. This means that the predictions from the analysts will be more favorable, which in turn will boost the stock market.

An article from CNN Money on the rising rates (http://money.usnews.com/money/blogs/the-smarter-mutual-fund-investor/2013/05/24/will-rising-interest-rates-hurt-the-stock-market) argues that the rising interest rates will not have a negative effect on the market. A study conducted by JP Morgan showed that over the past 50 years 10-yr treasury bonds actually have a positive correlation with the S&P 500. They speculated the reason to be the FED works to relieve the economy in hard times by lowering interest rates. Although raising interest rates mean less big purchase spending, it also signals that the economy has recovered. Analyst see this as a good sign and the market continues to grow. Although the interest rates are at an all time low, as the rise it is unlikely that we have any major market meltdown.

In my personal opinion, I believe that the Analysts will way both the quantitive easing and the stronger economy when betting on the market. I believe that they will be a little more hesitant as interest rates will begin to rise, however I think they will bet bigger on the rebounded economy. I wouldn’t be surprised if long term the market continues to grow, but at a slower rate than we have witnessed in recent months.