The knock-on effects of higher interests is the key risk I’m following these days.
You may have seen headlines about the risk of rising interest rates. The 10-Year Treasury yield now sits above the 3% line.
You see, the interest rate is at the heart of doing business. As interest rates rise, the cost of doing business increases with it.
Consider margin impact first. Rising commodity prices are getting passed to consumers. Deere (NYSE: DE) reported higher steel costs. This is forcing them to raise prices.
Next consider a stronger dollar.
Shortly after Trump was elected, the dollar was super-strong – worth almost 1 Euro.
Trump talked the strong dollar down 20% – to 0.81 Euros.
A weak dollar is great for US stocks (foreign exchange boosts the value of off-shore sales, for example).
But now the dollar has started to reverse: it is now $.85 Euros (a 5% increase). This isn’t “panic-worthy,” but it does dent corporate profits.
The trajectory is really what matters – it hurts stocks. Especially with another rate hike around the corner: money will flow to the dollar, further strengthening it.
Lastly, there is also rising borrowing costs. From a fundamental perspective, the impact is textbook: higher interest rates means higher borrowing costs and more expensive mortgage rates for the average American.
This will slow the housing and auto markets (we know how core they have been to the US economy). So we should expect companies in these sectors to guide down. (However, other companies benefit from higher rates – like banks).
An equally important issue tied to higher borrowing costs is corporate debt.
When money was practically free, companies loaded up on debt and bought back shares. But now rates are a lot higher, which reduces share buybacks. And that cuts stock price premiums.
Now all these companies saddled with debt will have to refinance. And guest what… rates are now higher. Many companies will tank. Some will go under (think Toys’R’Us).
In essence, the market is asking a question: what growth can you deliver at higher levels of interest rates?
If these companies cast any doubt about their growth prospects, look out below…
Editor of Moneyball Economics