Higher Interest Rates Are Pressuring Stocks — So Why Does the Market Keep Rising?
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Higher interest rates are supposed to make stocks less attractive. Yet, despite rising borrowing costs and pressure on valuations, the US stock market has continued to climb. The explanation may not be that interest rates no longer matter, but that corporate earnings are growing fast enough to offset their impact.
For investors, this distinction is important. The market’s resilience could reflect genuine business growth rather than simply investors paying increasingly higher prices for stocks. However, with valuations still elevated, the strength of future earnings will be critical.
Higher Rates Are Changing How Investors Value Stocks
When interest rates rise, investors generally demand better returns for taking risks. Higher yields on relatively safer assets can also make equities less attractive, while increased discount rates reduce the present value of companies’ expected future cash flows.
This pressure is already visible in stock valuations. According to FactSet figures cited in the original report, the S&P 500’s forward price-to-earnings (P/E) ratio fell from 20.4 times at the end of the second quarter to 19.2 times on September 25.
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In simple terms, investors are paying less for each dollar of companies’ expected earnings than they were a few months earlier. This process, known as valuation compression, can limit stock-price gains even when corporate performance remains healthy.
Yet the market has continued to advance. The reason lies in earnings growth.
Strong Earnings Are Offsetting Valuation Pressure
Stock prices can rise when companies generate higher profits, when investors are willing to pay more for those profits, or through a combination of both.
Recently, earnings growth appears to have played the larger role.
Since June 30, the S&P 500’s forward 12-month earnings-per-share estimate increased by 8.9%, while the index itself gained just 2.7%. Over the same period, its forward P/E ratio declined from 20.4 to 19.2.
These figures suggest that improving earnings expectations have helped support share prices even as investors have become less willing to pay premium valuations.
FactSet also estimated third-quarter S&P 500 earnings growth at 29.1% year over year, up from 26.7% at the beginning of the quarter. If companies deliver that growth, it would mark the third consecutive quarter of earnings expansion above 25% and the eighth consecutive quarter of double-digit growth.
Such performance provides an earnings cushion. When corporate profits grow sufficiently quickly, stock prices can still rise even if valuation multiples decline.
For example, if earnings increase by 15% while the valuation multiple contracts by 5%, a stock can still deliver a positive return, assuming other factors remain unchanged.
Why Investors Should Remain Cautious
Despite the recent valuation decline, US stocks are not necessarily cheap. The original report placed the S&P 500 at approximately 19 times forward earnings, compared with roughly 23 times for the Nasdaq 100 and 24 times for the Russell 2000.
These valuations leave the market vulnerable if earnings disappoint or interest rates rise more sharply than expected.
Companies may also face higher financing costs, which can weaken profit margins and reduce investment. If earnings growth slows while valuation multiples continue to contract, the two pressures could work together to push stock prices lower.
Investors should therefore look beyond index performance and examine whether individual companies can sustain revenue growth, protect margins and meet earnings expectations.
What This Means for Investors
The stock market’s resilience does not prove that higher interest rates have lost their influence. Instead, it suggests that strong earnings expectations have so far outweighed the negative effect of lower valuations.
The next phase will depend on whether corporate profits can maintain their momentum. If earnings continue to grow, stocks may remain supported despite restrictive financial conditions. If growth weakens, elevated valuations could leave investors with less protection against a correction.
For now, the key question is not simply whether interest rates will rise or fall. It is whether corporate earnings can continue doing enough to justify the prices investors are paying.
