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Interest Rates and Stocks

Updated: Nov 20

How do interest rates affect stocks?


Rising interest rates tend to result in stocks falling in value because of lower future earnings. A higher inflation rate leads to higher interest rates, which can adversely impact the stock market. When interest rates rise, stock investors tend to be less bullish on stocks because the value of future earnings will be less attractive to bonds.


Why are growth stocks more sensitive to interest rates?


When long-term interest rates rise, this will result in growth stocks being heavily discounted since they have longer-term cash flow horizons than value stocks. As a result, growth stocks appear less valuable, all things being equal. Rising interest favors value stocks and hurts growth stocks, at least from a relative perspective.


Why do technology stocks fall when interest rates rise?


Most technology stocks are growth stocks with high price-to-earnings ratios and low dividend payouts. Since higher interest rates slow corporate business cash flows, this can lead to a decline of reinvestment in research and development and innovation projects hence future growth projections.


Is there light at the end of the tunnel for growth and technology stocks?


Is it all about interest rates?


It probably depends on the direction of interest rates. The Fed tightening cycle has pushed interest rates sharply higher, as evidenced by the well-established 1-year uptrend channel in TNX between 3.57 and 4.65/5.25. An inverse correlation remains intact between TNX and COMPQ.


When TNX rallied, the technology-laden index sold off and vice versa. The actions of the bond market have directly influenced the direction of the stock market and, in particular, growth areas such as COMPQ.


The Fed tightening process to fight inflation has led TNX to soar to 4.234 during Oct 2022. At the same time, COMPQ has plummeted to 10,321-10,343 during Oct/Nov 2022.


So, is the recent Oct/Nov top in TNX at 4.234/4.214 signaling another oversold stock market rally, including growth areas such as technology and COMPQ?


It is unclear if US interest rates have peaked as TNX's primary trend remains an uptrend.


Nonetheless, the recent violation of the 50-day ma (3.851) hints at a near-term TNX decline toward 3.483-3.57 or the Sept 2022 breakout and the bottom of the uptrend channel.


Violation of the uptrend and the prior breakout can lead to a decline toward 2.987-3.13, corresponding to the 38.2% retracement from Dec 2021 to Oct 2022 rally and the pivotal 200-day ma. Below 2.987 and 2.788 (50% retracement) can spark a significant TNX decline to 2.447-2.606 (Jul 2022 low and the 61.8% retracement).


Remember not to trade against the primary trend. A convincing surge above the 50-day ma (3.775) can extend TNX toward 3.964 (Sept 2022 high) and above this to pivotal resistance at 4.214-4.234 (Oct/Nov 2022 highs).


A breakout of the prior reaction highs signals the resumption of the primary uptrend and warns of the next TNX rally toward 4.65/5.25 or the top of the 1-year uptrend channel.


What does this mean for COMPQ?


COMPQ retains its primary downtrend since its peak in Nov/Dec 2021. However, oversold rallies are still possible.


COMPQ may be stagging another oversold rally as evidenced by a potential double bottom between 10,321/10,343 (Oct/Nov 2022 lows) and 11,176-11,199 (10/4 and 10/25/22 highs).


A confirmed breakout suggests 877.73 points renders a COMPQ target at 12,077, or near formidable resistance at 11,952-12,112, coinciding with the top of the Dec and Mar 2022 downtrends, Jun/Sept 2022 highs (12,317/12,266), and the 38.2% retracement from Nov 2021 to Oct 2022 decline.


A convincing breakout here confirms the start of a sustainable rally to 13,128-13,189 (8/15/22 reaction high and the 61.8% retracement), 14,096 (Nov/Dec 2021 downtrend), and 14,490-14,620 (Feb/Mar 2022 highs).


Source: Courtesy of StockCharts.com

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