Are Changes In The Interest Rates The Good Indicator Of The Market Movements?

Are Changes In The Interest Rates The Good Indicator Of The Market Movements? by Bargain Value

Today, we will focus on the macroeconomic connection between levels of interest rates and the stock market. Interest rates are very important tool in the hands of central banks. They use them to impact money supply and to stimulate or cool down the national economy. They are tightly connected with the level of inflation and affect markets. It is common knowledge, that low-level of interest rates means cheaper debt for companies. If the companies can get cheaper financing, they take it and invest in development. Investments are good for the economy and strong economy is good for the markets. When the state of national economy is wrong and there is a threat of deflation,  the central bank must intervene, because of their inflation target. On the other hand, when inflation is to high, interest rates are lifted and it will probably cool down the economy.

Let’s see how these changes affect the market. In our analysis we will base on LIBOR GBP 3M (as one of the many counted interest rates) and as before, on FTSE SMX (why we choose this index is explained in previous article). We think, that very high interest rates are not good for the investors, because they could be a sings of coming bear market. To prove it, we have measured and smoothed changes in LIBOR (6 months simple moving average of LIBOR changes yty), which are presented as LIBOR SMA 6m and show this on the one chart with FTSE SMX index. Results are presented below:

interest rates

We can see, that LIBOR SMA 6m varies from -80% to almost +40% and some correlation can be found. We have 4 peaks and they are marked on the chart below. 3 black arrows present peaks, after which we experienced falling FTSE SMX. In two cases they appeared almost simultaneously with the peak of the index and in one case after this. The blue arrow shows peaks, which did not indicate bear market.

interest rates

Now, let’s check how strong are these signals. We distinguished the exact date of each peak and check, how FTSE was changing during one year after this event. Chart below shows how much the index fell or raised:

interest rates

As we can see, in 3 cases the peak of LIBOR SMA 6m indicated a period in which the FTSE SMX was falling. After peak in 19.10.2000 the index fell 28%. The peak in 02.01.2008 indicated very strong bear market and FTSE SMX dropped 45%. After the other peak, the index was rising, but the growth was not higher than 20%. Summing up, in 3 out of 4 cases changes in LIBOR were connected with a bear market, so effectivness of our theory is 75%. 

Now, let’s go to our most important question. What will happen in the future? The LIBOR formed a peak in October 2014, but this one is a little bit below the others, so it can be a false signal. Dynamic of LIBOR is right now very low and the market is moving in rather horizontal direction. It is very hard to say what that means. The best what we can do, is to wait for more strong-minded decisions from the Central Bank and see, if the interest rates will fall or maybe rise again.

Remember, that a good investor always look at the economy as a whole. Macroeconomic indicators like GNP, interest rates or LEI (Leading Indicators Index) are very useful and we will talk about them more in the future.