How interest rates affect stocks

When a central bank moves rates, it reaches share prices three different ways. They work at different speeds and hit different companies. So "rates up, shares down" holds on average and tells you nothing about any one company.

• · Future profits are worth less today, so the price people pay per dollar of profit shrinks.
• · Companies with debts pay more interest, so their actual profits fall.
• · Cash and government bonds start paying something, so shares have to compete for the money.

A company's worth the profits it'll make, converted into today's money. That conversion uses an interest rate. Put the rate up and every future dollar shrinks. Dollars arriving further away shrink most.

So the damage lands unevenly. A water company earning steadily right now barely notices. A company expecting most of its profits in seven to twelve years gets hit hard, because that's exactly where the shrinking bites deepest.

People shorten this to "growth shares are rate-sensitive". It's all timing arithmetic, and it says nothing about whether the business is any good.

Margin Call does this directly. A company's target multiple depends on interest rates, on central bank bond-buying, on its sector, and on how long its growth should last. A run of rate rises squeezes multiples across the market, and squeezes the long-dated ones hardest.

The second route changes the profits themselves. A company whose loan interest floats with rates pays more when rates rise. So does one whose cheap fixed-rate loan is about to run out. That money comes straight out of profit.

It arrives late. Debt only changes on its own schedule and ignores the day of the announcement. A company whose loan matures in a year gets a year of calm and then a nasty step up.

It's picky, too. Two companies in the same sector, with the same sales, can react completely differently depending on how they borrowed.

In Margin Call, rates feed through debt costs into earnings per share. So a company with big borrowings really does earn less after a run of rate rises. The engine changes the profits instead of nudging the price.

The third route is the simplest. When cash pays nothing, owning shares is barely a decision. When a short government bond pays five per cent for almost no risk, every share has to earn its place against that. Some investors move their money.

So cuts often lift the market before any company earns a penny more. And the expectation of cuts moves prices more than the cuts themselves. The market is repricing the alternative.

Today's rate matters less than where people think it's going. A cut everyone already assumed changes nothing on the day. The moves come when expectations change.

The yield curve carries those expectations. Its shape shows what the market thinks policy does next.

Which sectors lead is fairly predictable. Rate-sensitive sectors tend to lead coming out of a cutting cycle, and defensive ones lead going into a hiking cycle. The rotation view in Margin Call spells out which sectors lead in each phase, using the same relationships the engine applies.