During Janet Yellen’s Congressional Testimony yesterday, the Federal Reserve Chairman stated:
“Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance”.
Her words reverberated throughout the whole world and caused markets, namely the NASDAQ, to rise substantially. Those words triggered the notion that low interest rates will be the new norm in the foreseeable future.
Low interest rates usually benefit younger growth stocks, mainly innovative technology companies. Newer growth companies tend to find raising capital by giving away ownership to new investors to be less costly, while more mature companies tend to find borrowing, through taking out loans or issuing bonds, to be less expensive to raise funds. Reason being that tech/growth companies usually do not have long historical steady profits to show and could not provide banks with solid financials to prove they can repay their debts on time. Therefore, banks and lenders tend to increase interest rates, to compensate for the higher risk, on loans they grant to growth-oriented firms.
In the other hand, mature companies tend to generate steady profits. There’s less incentive to give away ownership because these companies know they are profitable and will, most likely, continue to make money in the future. So, why would they give away ownership on a business (or “system”) that already works? Of course, banks also tend to grant loans with lower interest rates to more mature companies due to the lower risk perceived by lenders in the marketplace.
Since, interest rates seem to remain low for the forseeable future, growth stocks will benefit the most in this environment. They can raise capital more easily through less costly means with a low interest rate economic atmosphere. If we look at the one month chart below, we can see that the NASDAQ outpaced the Dow Jones Industrial Average and the S&P 500 recently.
Also published on Medium.