Ever wonder why the stock market often tanks when there's good economic news reported? That doesn't seem to make sense, but it's all related to interest rates. Ben Bernanke (Alan Greenspan's successor) and his buddies at the Federal Reserve set interest rates, trying to keep inflation at bay and promote a healthy economic environment. When positive economic news is released, such as lower unemployment figures, rising wages, or growing national productivity, the specter of possible inflation comes out to haunt the market. Economies growing too quickly can spur inflation, with too much currency in the marketplace leading to the weakening of the dollar and rising prices.
To stem inflation, the Fed notches up interest rates to decrease the amount of borrowing and slow down the economy. Rising interest rates render bonds more attractive, because they offer fixed incomes. Investors pull money back from stocks, which are hit doubly with the threat of shrinking corporate earnings and the attractiveness of growing bond yields.
Got that? If not, re-read it once or twice. It's a bit complicated and can hurt your head until it sinks in. Know that the Fed has been regularly and gradually hiking rates for a while now -- and that trend may continue for a while.
Here's the Fool scoop on the Federal Reserve when it was led by Alan Greenspan, a Fool take on the Greenspan-Bernanke transition, and info from the horse's mouth itself, the Fed.
On a related topic, Mathew Emmert has written about how to prepare a Fed-proof portfolio.
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