Higher Interest Rates Won’t Kill the Bull Market, but This Could

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There’s a saying that bull markets climb a wall of worry.

Investors are always looking for something to go wrong when things are going right. With stocks at or near all-time highs, investors have begun to fret over higher interest rates and their potentially negative impact on economic growth, coming inflation, and what higher rates portend for stock-market valuations.

Higher rates, however, probably won’t kill the bull market. Corporate management teams might do that all on their own. New stock sales by companies already flush with cash are sending a coded message to investors that things might be as good as they get.

Interest rates are always a concern for the market and the overall economy. Higher interest rates make everything more expensive including home mortgages and car payments. They also make it harder to start and grow businesses.

For the market, higher interest rates tend to depress price/earnings multiples. The reason is, essentially, math. If investors can make more interest on their bonds, they demand more return from stocks. Higher returns tomorrow means paying less for stocks today.

Here’s the thing. Inflation isn’t running wild. The yield on the 10-year Treasury note is about 1.7%, up from recent lows, but lower than where yields finished 2019. That isn’t a high enough rate to choke off economic growth. At 3% and higher, the oxygen intake could start to get cut off.

Inflation expectations aren’t out of line with history either. Inflation expectations can be measured by the difference in traditional government bond yields and the yield on Treasury inflation-protected securities. Essentially, the face value of an inflation-protected bond goes up by the consumer-price index. The difference in yield between the traditional bond and the inflation-protected security is the level of inflation required to make an investor the same return on both.

Today, the 10-year yield is at roughly 1.7%. The 10-year inflation-protected yield is negative 0.7%. So inflation has to average about 2.4% for both bondholders to get the same return.

Investors should watch out for inflation, but they should be more concerned with recent stock sales by companies flush with cash.

QuantumScape

(ticker: QS),

Nikola

(NKLA), and

Canopy Growth

(CGC) are three cash-rich companies that have sold, or are planning to sell, more stock.

QuantumScape is an electric-vehicle battery start-up pioneering solid-state lithium anode batteries. It doesn’t generate significant sales. The company needs cash to…