Question

The Financial Markets and Interest Rates

To most of the public, the financial markets are an enigma. They go up, they go down, and most have very little idea as to why. If you fall into this category don't feel bad because many who work in the financial industry are puzzled as well! The truth is that there are many factors which influence the markets such as: economic cycles, consumer preferences, taxation, regulation, high frequency trading, and news among many others. The question is how many of those factors can we as small investors control? Few, if any.

The best we can do is learn ways to identify assets which are undervalued and purchase those for capital appreciation and/or dividends. Every single asset class and sector goes through periods of being undervalued, overvalued, or fairly valued. This can be due to one or many of the aforementioned market influencers.

Here is a historical chart of the S&P 500

500 1,000 1,500 2,000 2,500 3,000 3,500 January 1959 January 1961 January 1963 January 1965 January 1967 January 1969 January 1971 January 1973 January 1975 January 1977 January 1979 January 1981 January 1983 January 1985 January 1987 January 1989 January 1991 January 1993 January 1995 January 1997 January 1999 January 2001 January 2003 January 2005 January 2007 January 2009 January 2011 January 2013 January 2015 January 2017 January 2019 Copyright © 2019 www.FedPrime Rate.com January 4, 1960 Through November 19, 2019 Standard & Poor's 500 Index History

Additionally, here is a historical chart of the Fed Funds Rate



-How do you think interest rates affect the economy and markets?
-Where do you think interest rates are headed and why? Is this good or bad?
-Do you think markets are currently undervalued, overvalued, or fairly valued? How about certain asset classes?
-How does taxation and inflation work against your objective of wealth building?
-Are there ways you can "defeat" the effects of inflation and taxation?

Answer 1

Answer a) A decrease in federal interest rates force bond holders to move their investments from the bond to the equity , which will rise with the influx of new capital. Similarly the decrease in interest rate will increase the borrowing capacity of industry and business house , which will create new capital and enhance the productivity in economy. It is very obvious from  the graphs interest has inverse relation with movement of the stock market .

Answer b) The interest rate are going down due to slow down in economy , due to sluggish demand in market level of production is going down, Such slow down situation in economy can be improved by supply of fund , by lowering interest rate.

Answer c) On the basis of current study of P/E ratio of US stock market , the situation symbolized a overvalued market condition.As the average long-term P/E ratio is roughly 15 for U.S. stocks. The IT industry is most overvalued sector in current market situation

Answer d) The taxation and inflation reduce the net effective return on the investment or portfolio.

Effective Real return = Nominal return - Inflation - Tax

Answer e) In broader sense no one can defeat the effect of taxation and inflation but yes in narrow sense and in terms of investment return , we can defeat the ill effect of these by proper investment planning and better portfolio selection . Like investing in STRIP instead of normal bond can reduce the effect of inflation , similarly tax protection portfolio designing may reduce the tax effect.