How Interest Rate Hikes Could Lead to a Bear Market
An increase of only 0.50 percent in rates could send stocks down by 20 percent or more
In 1994, the Federal Reserve, led by its chairman Alan Greenspan, surprised markets by aggressively hiking interest rates five times, from 3.00 percent to 5.5 percent. After three consecutive years of rising stock prices, the S&P 500 index was down by 1.5 percent for the year. There were also unintended consequences related to the rate hikes, such as Orange County losing $1.5 billion on leveraged interest-sensitive derivatives contract. Fast forward to 2021: Why did markets recently have one of their worst weeks in nearly eight months in reaction to the Fed signaling it might raise rates in late-2022? I’ll use Walmart’s stock as an example to show how increasing interest rates can cause stock prices to decline — even a 50 basis points (0.50 percent) increase in long-term rates could result in a bear market decline of more than 20 percent in stock prices.
Expected Dividends
In order to understand why the stock market cares so much about interest rates, let’s take a look at what drives the value of stocks. It’s all about expected cashflows. Let’s suppose you buy Walmart’s stock — recently around $135 per share — and plan to hold on to it for the…
