How interest rates affect stocks

When a central bank moves rates, the effect reaches share prices by three separate routes. They act on different timescales and on different companies, which is why "rates up, stocks down" is true on average and useless in particular.

• — The discount rate — future earnings are worth less today, so multiples contract.
• — Debt service — leveraged companies pay more interest, so actual earnings fall.
• — The alternative — cash and bonds now pay something, so equities compete for money.

A company is worth the earnings it will produce, converted into today's money. The conversion uses a rate, and when that rate rises every future dollar shrinks. Crucially, dollars further in the future shrink more.

So the damage is not spread evenly. A utility earning steadily today loses relatively little. A company whose profits are expected mostly in years seven to twelve loses a great deal, because that is precisely where the discounting bites hardest. This is the entire mechanism behind "growth stocks are rate-sensitive" — it is arithmetic about timing, not a claim about business quality.

Margin Call models this directly: a company's target multiple depends on rates, on the quantitative-easing stance, on its sector and on how long its growth is expected to last. A hiking cycle compresses multiples across the market and compresses long-duration ones most.

The second channel is not about valuation at all — it changes earnings themselves. A company with floating-rate debt, or with fixed-rate debt maturing soon, pays more interest when rates rise. That interest comes straight out of profit.

This arrives with a lag, because debt reprices on its own schedule rather than on the day of the announcement. A company with a maturity wall a year out has a year of grace and then a step change. It is also selective: two companies in the same sector with the same revenue can respond completely differently depending on how they are financed.

In the simulation, rates propagate to corporate earnings per share through debt service costs, so a leveraged name genuinely earns less after a hiking cycle. It is not a sentiment adjustment applied to the price.

The third channel is the simplest. When cash pays nothing, holding equities is barely a choice. When short-dated government debt pays five per cent risk-free, every equity has to justify itself against that, and the marginal investor moves.

This is why rate cuts often lift the market before any earnings improve, and why the anticipation of cuts moves prices more than the cuts themselves. The market is repricing the alternative, not the businesses.

The rate itself matters less than the path expected for it. A cut that everybody already assumed changes nothing on the day. The moves come from revisions to the expected path.

The yield curve carries that expectation: the shape of it is the market's view of where policy goes. And the sector rotation that follows is fairly consistent — rate-sensitive sectors lead coming out of a cutting cycle, defensives lead into a hiking one. Margin Call's rotation view states which sectors lead in each phase of the cycle, which is the same relationship its sector modifiers encode.

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