With the Federal Reserve announcing on Sept. 21 that it would increase the target for the federal funds rate once again in keeping with its recent campaign to crush inflation, investors everywhere are trying to figure out what rising interest rates mean for their portfolios. As it turns out, that's a pretty complicated question, but the most straightforward answer is that it'll put downward pressure on the market.
Still, higher rates aren't going to affect every stock in the same way, so let's take a look at two reasons why you might not need to overly worry about it, and two reasons why you should probably be at least a bit concerned.
1. Not all companies need to borrow money
The first reason you shouldn't worry about the rising federal funds rate is that it isn't the be-all and end-all for growth in all businesses. Profitable companies can often generate enough free cash flow (FCF) to keep penetrating their markets and making new products without the help of any outside capital. That means there will still be good investments to find as rates rise, even if the market's general trend continues to be downward.
Take a company like Intuitive Surgical (ISRG -0.18%), for example. It develops robotic surgical units for hospitals and also sells robotic toolheads, imaging hardware, and packages of maintenance services for its technologies. It's strongly profitable, it's growing its top line steadily, and it's entirely debt-free. Furthermore, it has more than $4.4 billion in cash, which is more than enough to cover its cost of goods sold (COGS) of around $1.7 billion and its total operating expenses of roughly $2.1 billion in 2021.
Intuitive has no reason to take out new debt right now, so it probably won't, and it'll likely keep growing anyway. Rising interest rates are unlikely to hurt it directly, so it doesn't need to be a major worry for shareholders.
2. Not all corporate customers need to borrow money
Another closely related reason you shouldn't worry about rising interest rates is that there are many businesses with customers that don't need to borrow money to continue buying products or services.
In Intuitive Surgical's case, its customers are hospitals. Most hospitals wouldn't be solvent for very long if they had to take out new debt just to purchase the consumables, accessories, and maintenance contracts needed to operate their surgical robots, assuming they have robots at all. And assuming those hospitals want to keep using Intuitive's robots to do surgeries, stopping their purchasing isn't an option.
The story is much the same for many other businesses. If there's no need for a company to borrow money to buy a product that it can't do its core activities without, there's one less constraint for things to continue as normal.
Of course, that's not the entire story, and there are in fact at least a couple of reasons why investors may want to worry about rising interest rates.
1. Rate hikes could go on, hurting even resilient businesses
As the cost of borrowing increases, liquidity drains from the economy, and eventually it'll start to crimp demand all over. That's actually the entire point of hiking interest rates; having less money chasing the same quantity of goods tamps down on inflation. The trouble is, even the most resilient businesses can see their base of revenue come under pressure if the financial conditions get tight enough for long enough.
In Intuitive Surgical's case, that's likely to take the form of fewer customers buying its flagship da Vinci surgical robots. As of 2020, each da Vinci cost around $2 million, so buying one is a significant capital expenditure for customers. While the accessories, services, and surgical tool heads necessary to operate emplaced da Vinci systems aren't likely to see falling demand, higher interest rates mean that prospective buyers may have trouble getting the money they need to actually buy one.
Therefore, it's possible that Intuitive will see orders for new systems start to contract as its customers have a harder time borrowing cheaply, which is a medium-term threat to its share price.
2. Pessimistic sentiment can drive stocks down
The final reason why investors may want to be concerned about monetary tightening is that it tends to spoil the market's mood, especially for growth stocks. Even companies that don't need to borrow money can get dragged down as the market falls. And with talk of an interest rate-hike-driven recession in full swing at the moment, it's safe to say that the market is a bit skeptical when it comes to riskier stocks.
Unfortunately, there's not much that you can do to defend your portfolio from poor marketwide sentiment, aside from holding onto your shares. So, in that sense, there really isn't much of a reason to worry about it, assuming you're not going to add to your position. For now, it's probably best to avoid Intuitive Surgical and other growth stocks unless you can stomach a lot of risk and you plan to hold onto your shares for at least three to five years. Even if it isn't under immediate threat from rate hikes, the market's acting as though it is, and that could last for quite a while.
