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Rising rates hit steady stocks hardest
Why everyone pays more
Meta recently raised debt at 5 to 6% and would gladly pay 8%, because the return on the compute it builds is large. A 250 basis point rise for Meta means everyone else borrowing pays 250 basis points more too. Banks feel it first: their own debt reprices faster than their assets, so a widening credit spread loses them money.
The discount rate effect
Higher rates also raise the discount rate. A stock valued at a 3% or 5% discount rate is now valued at 8% or 10%, so the S&P 500 as a whole might hold up while any individual stock craters, especially ones prized for returning cash over thirty years.
The AI believers' problem
The same logic bends back on AI believers. Micron, Hynix, and Kioxia trade at two or three times earnings, which some AI believers find absurdly low. A world with enough demand for memory to justify far higher multiples is one where AI has changed the economy so drastically that everything should trade at two or three times earnings, and the stock market would crash.
How does the discount rate set a stock's value?
A stock is worth the sum of its expected future cash flows, each reduced by the discount rate for every year it lies ahead. One hundred dollars due in 30 years is worth about 41 dollars today at a 3 percent rate and about 10 dollars at 8 percent. Cash flows far in the future lose the most value when rates rise.
Why do banks lose when rates rise?
Banks typically hold long-term loans and bonds financed by short-term deposits, so rising rates cut the value of what they own faster than they cut what they owe. Silicon Valley Bank collapsed in March 2023 after losses on its long-dated bond holdings as the Federal Reserve raised rates. Wider credit spreads reduce the value of loans on the books.
Why are companies like Johnson & Johnson seen as steady?
Johnson & Johnson has raised its dividend every year for more than six decades. Railways have long earned steady revenue from freight that is hard to replace. Investors value such companies for dependable cash returns far into the future.
Why do memory makers trade at low earnings multiples?
Memory prices swing sharply between shortage and glut, so profits are highest at the top of a cycle and can vanish at the bottom. Investors often pay a low multiple of peak earnings because they expect the peak to fade. The multiple rises when a company's earnings look steady.
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