How do interest rates affect stock valuations?

Higher interest rates can significantly impact stock valuations, primarily because they influence the cost of borrowing and the discount rate applied to future earnings. When interest rates rise, it typically leads to increased borrowing costs for companies. This can result in higher expenses for firms that rely on debt to finance operations or growth, ultimately squeezing profit margins.

Additionally, investors often adjust their expectations for future cash flows when interest rates increase. Since stocks are valued based on the present value of expected future cash flows, a higher discount rate (reflecting higher interest rates) reduces the present value of those cash flows, leading to lower stock valuations.

Moreover, higher interest rates can shift investor preference towards fixed-income investments, such as bonds, which may become more attractive relative to equities. This shift can further depress stock prices, as capital flows away from the stock market in favor of safer, interest-bearing alternatives.

In summary, rising interest rates generally contribute to lower stock valuations due to increased borrowing costs for companies and a higher discount rate impacting investors' calculation of future earnings.