How Are Common Stocks Affected?
The reaction of common stock yields to fluctuations in interest rates, both nominal and real, is very similar to that of fixed-income security prices, and that similarity is quite natural. Regardless of whether an investment is made in common stocks or fixed income securities, the expected result is a satisfactory rate of return. The typical measurement for common stock returns is the return available from short-term bonds or the risk free rate. When returns from fixed-income securities are low, the stock market becomes more attractive, since even common stocks with relatively low dividend yields provide a competitive alternative to fixed income securities. On the other hand, at the peak of an inflation cycle, stock prices are very high. Their returns and yields compare unfavorably with the high yields available from fixed-income securities and there is less risk of loss of principal from fixed-income securities.
