Interest rates

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markraz
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Interest rates

Post by markraz » 19 Oct 2017 22:43

Hi, I realize equity markets hate higher interest rates. I'm curious what real impact they have on the markets?
I have read that "companies need to borrow at lower rates to create jobs and expand" blah blah blah.. Yet that to me seems to be pretty much a charade since majority of the money that makes up the markets is from huge companies like Apple and Google, Microsoft. Berkshire Hathaway Amazon.com. Facebook. These companies have 100s of billions in and cash overseas, and they don't even need to borrow money. So are higher rates just a a negative physiological effect? Or is there actually a valid reason why the market cares? Lastly Fed Rate is projected to go to about 4.5% by 2022. Is this going to crash the market when they go back to normal levels and is this rabid bull market over?

thanks

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ghariton
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Re: Interest rates

Post by ghariton » 21 Oct 2017 13:39

Simplifying greatly, rising interest rates have two offsetting impacts on equity prices. First, conceptually at least, the price of a share is the present value of all future cash flows that the investor can expect to receive -- dividends, buybacks, and liquidation in the unfortunate event that this is necessary. Given a set of future cash flows, the higher interest rates, the higher the discount rate, hence the lower the present value, hence the lower the price.

On the other hand, many see rising interest rates as a leading indicator of accelerating growth in the economy. If so, all else equal, companies' profits will be higher in future, and so, we hope will be their dividends and buybacks. That makes for larger cash flows and so a higher present value and a higher share price.

Which of the two effects will be bigger? That depends on the nature of the business and the sensitivity of the capital structure and of its financing generally to interest rates.

George
The plural of anecdote is NOT data.

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AltaRed
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Re: Interest rates

Post by AltaRed » 21 Oct 2017 13:54

There is also the effect, beyond higher discount rates, that the PV of future cash flows will be less due to higher debt servicing costs. This particularly affects capital intensive stocks with high(er) D/E ratios. This may actually be more significant than discount rate changes, especially in recent times as companies loaded up on cheap debt. I should be paying more attention to this component in my stock portfolio.
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patriot1
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Re: Interest rates

Post by patriot1 » 21 Oct 2017 19:53

ghariton wrote:
21 Oct 2017 13:39
the price value of a share is the present value of all future cash flows that the investor can expect to receive -- dividends, buybacks, and liquidation in the unfortunate event that this is necessary.
Fixed that for you. "Price is what you pay, value is what you get". :D

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deaddog
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Re: Interest rates

Post by deaddog » 21 Oct 2017 21:39

patriot1 wrote:
21 Oct 2017 19:53
ghariton wrote:
21 Oct 2017 13:39
the price value of a share is the present value of all future cash flows that the investor can expect to receive -- dividends, buybacks, and liquidation in the unfortunate event that this is necessary.
Fixed that for you. "Price is what you pay, value is what you get". :D
Price is an agreement between a buyer and a seller as to they think the value is at that moment. One of them is probably going to be wrong
Most of our so-called reasoning consists of finding arguments for going on believing as we already do.( J.H. Robinson)

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ghariton
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Re: Interest rates

Post by ghariton » 21 Oct 2017 22:30

Generally speaking, price is what the seller is asking for. There may or may not be any buyers at that price, hence there may or may not be a transaction. Of course, the buyer is free to make public a price at which he is willing to buy. But that is much rarer. Although it does happen regularly in financial markets. Heck, a market maker regularly quotes two prices for the same thing.

As to patriot1's point that price is what you pay, value is what you get, that may be true, but it seems irrelevant to me. If one thinks of value as a subjective opinion of the buyer, then the statement is a truism. If, on the other hand, the value is intended to be objective, as in intrinsic or fundamental value, then I submit that it is ill-defined and hence unknowable. All we can observe are the prices at which securities change hands.

George
The plural of anecdote is NOT data.

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deaddog
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Re: Interest rates

Post by deaddog » 21 Oct 2017 23:24

ghariton wrote:
21 Oct 2017 22:30
Generally speaking, price is what the seller is asking for. There may or may not be any buyers at that price, hence there may or may not be a transaction. Of course, the buyer is free to make public a price at which he is willing to buy. But that is much rarer. Although it does happen regularly in financial markets. Heck, a market maker regularly quotes two prices for the same thing.
In any situation where the price is negotiated which includes trading securities the buyer usually discloses the price he is willing to pay. Especially in an auction type setting.

Attending an auction is great training for an aspiring trader. You get to see how emotion can override common sense as the bidding heats up. A good exercise in supply and demand.
Most of our so-called reasoning consists of finding arguments for going on believing as we already do.( J.H. Robinson)

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