Higher interest rates can be scary for stocks — but it's not that simple

Stocks have a bond problem. But enough is enough. The market is currently in its longest oversold stretch since the period just after the Iran war started and into the lows of the year in late March. The S & P Short Range Oscillator has been flashing oversold for 14 straight sessions. Our discipline when this momentum indicator that Jim Cramer has trusted for decades goes this negative says it's time to buy stocks. During the Oscillator's only other oversold stretch in 2026, it was below the minus-4% threshold for 23 sessions in a row on either side of the S & P 500 's year-to-date closing low on March 30. Back then, with no off-ramp in sight in the Middle East, oil was marching higher, stoking inflation fears, and bond yields went along for the ride. We were putting money to work in March before the market ripped higher. It was the right move then. We believe buying is also the right move now. Not going full bore, as Jim said during Wednesday's Morning Meeting, but nibbling. With the market this oversold and the history of buying when the herd is heading for the exits on our side, we look at stocks right now with an opportunistic bent. Ahead of the meeting, we put our money where our mouths are — buying more shares of two more defensive-leaning names in Cardinal Health and BNY . Jim called Cardinal Health a "breakout and crushed" stock that looks ready for a comeback. Those are the names he is interested in. However, we understand the reticence to buy. The U.S. and Iran are still having a tough time reaching a peace agreement that would fully reopen the Strait of Hormuz, though Middle East oil exports have recovered significantly , which is encouraging. While oil prices are well off their worst levels of the year, West Texas Intermediate crude is still up 40% since the war started in late February and 57% year to date. Persistent inflation concerns led the Federal Reserve to increase interest rates earlier this month for the first time in three years. At least one more Fed rate hike is expected before year-end. The bond market wants the Fed to move more quickly, with traders pushing the 30-year Treasury yield to its highest level since early 2002 and the benchmark 10-year Treasury yield to nearly two-decade highs. US30Y US10Y YTD mountain Yields on 30-year and 10-years Treasurys YTD To be sure, yields were somewhat mixed Wednesday, depending on the maturity of the bond, after the Fed's preferred inflation gauge came in cooler than expected and stocks were higher. Jim always says these oversold bounces are possible. While encouraging and raising the odds of the Fed holding borrowing costs steady at its October meeting, the level of market rates has become quite competitive with stocks — not to mention, elevated inflation still eats away at returns. So, higher rates are a headwind to asset valuations, no matter how you look at it. This helps explain why the market has had narrow leadership of late, with many stocks underneath the hood struggling; more than half of the S & P 500's constituents are trading below their 200-day average . However, the direction of rates does little to tell you what you're actually valuing, especially at the individual stock level, or whether there are other, more positive reasons strong enough to offset the anchor of higher rates to keep the asset in question afloat. If we were sitting in a classroom and being asked to explain the impact of rates on stocks and why we're looking past that, our answer would be that being a good investor is recognizing when you should buck conventional wisdom. Textbook thinking First, let's get the textbook stuff out of the way. The reason for the knee-jerk reaction of "higher rates, sell equities" is twofold. Higher rates lead directly to lower valuations (all else equal). If you're using a discounted cash flow model for your valuation analysis, then a higher rate environment means you need to increase the discount rate in your model. The higher the discount rate, the lower the present value. For those who lean more on a multiples-based approach to valuing stocks, such as price-to-earnings ratios, the thinking is the same. Future earnings are worth less when rates increase, so the multiple put on future years' earnings needs to contract. For those income-oriented investors who look for stocks with juicy dividend payouts, higher-yielding debt becomes especially interesting. If your goal is simply to generate passive income for annual living expenses — sacrificing long-term upside for reduced volatility — debt instruments like government Treasuries can deliver that much more safely, so long as the yield is enough to provide the needed cash flow. Higher yields on debt make that much more possible. Anyone who is going to be active in the market needs to be familiar with this textbook thinking. But they also need to know why it can so often fail. Consider why we are even seeing higher rates to begin with. The Fed controls the short end of the yield curve — and specifically, the policy rate known as the federal funds rate. This is what banks charge each other in overnight lending, and it ripples outward from there into longer and longer maturities. Central bankers adjust the target range on the fed funds rate for two reasons — their dual mandate of maximizing employment and fostering stable prices. The idea is that they can raise the overnight fed funds rate to make other borrowing costs higher and, in turn, reduce aggregate demand, thereby lowering the rate of inflation, while hopefully not roiling the job market. As is so often the case, if you want an edge in investing, you're not going to get it from a textbook. Instead, you need to layer on some street smarts. Street smarts If rates are a proxy for inflation expectations, then we need to consider what inflation indicates. Inflation is the result of more dollars chasing a limited amount of goods and services — competition for goods and services means that buyers are willing to pay more. The aggregate weighted-average rate at which prices are bid up is the inflation rate. If businesses and consumers are willing to pay more, it's because they are confident in their ability to do so. In other words, they feel good about the economy in which they operate. Therein lies the caveat to the thinking that higher rates demand lower present valuations on equities. Higher rates are a reflection of a hot economy — indeed, second-quarter U.S. gross domestic product increased at an annualized rate of 2.2%, according to new data released Wednesday morning; that's up from 1.5% in the Commerce Department's prior estimate. A hot economy means the Fed may raise rates to keep the economy from overheating (leading to a higher inflation rate), but it also means that money is flowing, consumers are buying, businesses are investing, and confidence is high that the good times will continue. That is exactly the type of environment you want to be a business owner in — and it's that business owner perspective from which we approach the idea of investing in equities. When you own stock in a company, you own a piece of the company. Think from the perspective of a business owner. Are sales going to be better when rates are high because everyone is bidding up the price of goods or services? Or would you rather do business in an environment in which rates are lower because the economy stinks and the Federal Reserve is therefore trying to stimulate demand? It doesn't take an MBA to figure out that sales do better when demand is strong. So, sell stocks because of higher rates, or buy stocks because of a strong operating environment? That's the question that actually matters, and if you're an active investor like us at the Club, the answer is going to be determined on a case-by-case basis. Sure, it makes the hunt for securities a bit tougher because higher rates really do mean you need to differentiate winners from losers. These are more unforgiving conditions. However, sticking to the basics of fundamental analysis means that while the selection standard may be higher, the process of determining winners and losers is largely unchanged. In the end, it always comes back to balance sheet health, revenue resiliency, profit margins, earnings quality, cash flows, and future growth expectations. You may accept a bit lower quality in a low-rate environment, and need to increase your standards when rates rise, but the process is unchanged. That's why having a process you can use in any market is so important. Real-world example Take Meta Platforms . On the one hand, you could apply the textbook across the board and simply determine that rates are higher, so Meta must suffer multiple contraction. On the other hand, you could go beyond that stock market 101 level of thinking. Do that, and you end up getting a much better sense of how to think about a stock like Meta. Do you sell Meta because the Fed is raising rates, making Meta's future earnings worth less in the here and now? Or do you buy Meta because they recently put to bed what could have been nightmare youth social media addiction litigation with relatively minimal consequences compared to what investors had feared, and then made several new hardware and software announcements that stand to accelerate growth and increase the earnings potential in coming years? What about the fact that if demand is strong enough, and when it comes to Meta's offerings we think this to be the case, that higher rates simply don't materially impact demand, assuming, of course, that rates don't rise so high so fast that they completely derail the economy? After all, investors tend to reward stronger growth rates — which is what you get when strong demand is met with new product categories that lead to greenfield revenue streams — like Muse and its ChatGPT-type moment , or the recently announced Meta Enterprise Platform . What should you do? Update your price target based on a lower multiple (or higher discount rate) due to higher interest rates, or update it based on a higher multiple thanks to the potential for accelerating sales and earnings growth? For us, it's the latter. Of course, if you were to ask us about a housing stock that relies on home sales or renovation demand, that's an entirely different story. Since lower rates are directly tied to demand in a name like that (think Club name Home Depot ), then rates really are a concern meaningful enough to keep us uninterested. That's the point. You cannot apply one high-level macroeconomic metric such as the yield on 10-year Treasuries to an equity portfolio and think that will tell you what to do with every stock you own. That said, there is one other factor to be mindful of when thinking about interest rates, and this is what will truly help in not only deciding if you should stay invested but also in figuring out if you should press your bet on an identified winner, or perhaps, look to take advantage of what may prove to be temporary, rate-induced weakness. That is, your investment horizon. Investment Horizon Our views, as laid out above, are for the long-term investor. Why does that matter? Because as long-term investors we have to consider that the goal is not to play the market so much as it is to identify great businesses at good prices, buy their stocks, and be patient. As the saying goes, we like to think about it more as a market of stocks, rather than simply the stock market. The thing about rates is that they are constantly changing. That doesn't mean we should ignore them, but it does mean that we need to think about long-term investments through interest rate cycles. If you think about it from the perspective of a business owner, that makes a ton of sense. You don't simply shut your doors when rates breach 5% and reopen them when they come back down. Rather, you build the business to thrive in the good times, and survive in the bad ones, so that it can thrive again when the bad time passes — as it always has throughout history. By taking into account your investment horizon, you can cut through the noise of rates. Going back to Meta, by focusing on the long term, we have the luxury of thinking not only about future earnings potential but also about future rate levels as well. The launch of the Muse personal AI agent and announcement of the Meta Enterprise Platform helps us look several years into the future and think about where earnings can grow to by then. It also lets us think through the cause of high rates and where those are going. Given that we think a decent portion of inflation is supply-related, and that supplies will start to catch up over time, reducing the rate of inflation — not to mention that the Fed is raising rates, which should also reduce overall demand — we can think through the high-rate environment in a more measured way. This allows us to conclude that if everything works out and we successfully address the root causes of inflation, the current rising rate headwind can become tomorrow's declining rate tailwind. So, while interest rate dynamics may impact your near-term thinking on when to buy, it shouldn't play as heavy a role in determining what to buy — unless, of course, interest rates really are material to the fundamentals, such as with housing-related stocks. But then again, even that analysis is about the impact on the fundamentals — not simply a first-level thought along the lines of "rates rising, sell equities." Bottom Line In the end, making broad-based determinations on whether to buy or sell stocks based on rates should be reserved for macro-level investors (meaning those that buy market or sector-wide exchange-traded funds), and short-term market participants, not active stock pickers with long investment horizons. Active stock pickers must instead consider the merits of each holding against the prospect of higher rates. In doing so, only then will you be able to determine if the rates are a reason to sell, or if instead, there is an even more material reason to stay the course, based on the company's own fundamentals. That's not to say that rates shouldn't impact your overall level of exposure. It's perfectly reasonable to raise cash levels overall on the idea that broader market pressure makes upside harder to find. However, it is to say that there are better ways to raise cash than simply taking a little off of each position, with no consideration of each company's own merits, both in the high-rate environment and once it passes. To steal a lesson from Warren Buffett, while rates certainly tell you about the direction of the present valuation of a business, all else equal, they do little to inform the internal strength of the operation (the fundamentals). Buffett has been the consummate buy-and-hold investor who generally ignores near-term rate moves. As long-term investors, we must be far more concerned with the fundamentals than anything else. Plus, when dealing with innovative companies that are constantly reinventing themselves and bringing to market world-changing technologies such as AI, rarely, if ever, can we actually say that all else is equal. That's why Jim calls his style of investing buy-and-homework, because investors should never buy and hold no matter what. He advocates staying on top of each holding and constantly stress-testing it against the reasons the stock was bought in the first place. (Jim Cramer's Charitable Trust is long META, HD, CAH, BNY. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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