From the policy rate to the stock price

The central bank sets an overnight rate and has no mandate for equities. Yet every equity desk stops for the decision. This lesson is the transmission — the first of the roadmap's three self-assessment targets, and the one that makes macro matter to someone who only trades stocks.

There are three channels. They can push in the same direction or fight each other, which is why the market's reaction to a hike is not always obvious in advance.

Channel 1 — the discount rate

A stock is a claim on future cashflows, and future cashflows must be discounted:

              CF₁        CF₂        CF₃
      P  =  ─────── + ───────── + ───────── + …
             (1+r)     (1+r)²     (1+r)³

That is the same equation as M4.1's bond, with uncertain cashflows and no maturity. Raise r and every term shrinks — mechanically, before any change to the business.

And because the exponent grows with t, distant cashflows shrink most. Which gives the single most useful idea in this lesson:

Equities have duration too. A company whose profits arrive in twenty years is a long-duration asset and behaves like a long bond. A company earning cash now is short-duration.

   long-duration equities            short-duration equities
   ─────────────────────────────────────────────────────────────
   unprofitable growth, biotech,     utilities, consumer staples,
   early-stage tech — value is       banks, energy — cash now,
   nearly all terminal value         modest growth
   HIGHLY rate-sensitive             far less rate-sensitive

This is why "the growth selloff" and "rates rose" are so often the same event, and why 2022's rate shock hit the Nasdaq far harder than the Dow. Not sentiment about technology — duration, in the M4.1 sense, applied to equities.

Channel 2 — earnings

The policy rate is raised to slow the economy, and a slower economy earns less. Higher borrowing costs squeeze corporate margins, capex is deferred, consumers with mortgages and credit-card debt spend less.

This channel is slower and less certain than the discount channel. Discounting repricing happens in minutes; earnings damage arrives over quarters, and might not arrive at all if the central bank engineers a soft landing. Much of the argument in any tightening cycle is precisely about how much of channel 2 to expect.

Channel 3 — the risk premium and the alternative

When the risk-free rate is zero, holding equities is close to compulsory — the phrase was TINA, "there is no alternative". When cash pays 5%, there very much is an alternative, and equities must compete for capital against a genuinely attractive risk-free return.

The classic framing:

   equity risk premium  ≈  expected equity return  −  risk-free rate

   risk-free rate up, expected equity return unchanged
        ⟹  the compensation for taking equity risk has FALLEN
        ⟹  equity prices must fall until it is restored

It is also a flow story, not only a valuation one: money-market funds and short-dated bonds genuinely compete for allocation when they yield 5%.

Why the decision itself does so little

From M4.2 — the decision is usually priced weeks ahead. What repricing happens on the day comes from the change in the expected path.

   scenario                                    typical equity reaction
   ─────────────────────────────────────────────────────────────────────
   25bp hike, fully expected, neutral tone     ≈ nothing
   no change, but "higher for longer"          DOWN — path revised up
   50bp hike, but signals it is the last       UP — path revised down
   25bp cut, but warns of recession            DOWN — channel 2 dominates

Look at the last two rows together. In one, a hike lifts equities; in the other a cut sinks them. Neither is perverse once you see that the market is trading the path and the reason, not the level.

Good news is bad news

The most confusing regime for a newcomer, and it follows directly:

   strong payrolls  →  economy running hot  →  central bank likely to
   tighten further  →  higher expected path  →  higher discount rate
                    →  EQUITIES FALL ON GOOD ECONOMIC NEWS

This inversion holds while the central bank is the dominant variable — 2022–23 being the clearest recent example, when strong labour data reliably sold equities off. It flips back to "good news is good news" once the tightening cycle is over and channel 2 (earnings) dominates again.

Knowing which regime you are in is most of what "following the macro" means. It is not a forecast; it is knowing which channel the market is currently trading.

The honest caveat

This is a set of mechanisms, not a model with predictive power. The channels have different speeds and can offset — a hike that raises the discount rate but convinces the market inflation is beaten can lift equities outright. Anyone who tells you a rate decision has a reliable directional effect on stocks is selling something.

What the framework buys you is the ability to read a move after the fact and to know which data matters. That is what the roadmap means by "enough macro to follow conversations about what's moving markets and why" — and it is deliberately less than a forecast.

Source: Howard Marks, Mastering the Market Cycle, for the cycle-level version of the same argument, and it is the roadmap’s pick. For the discount-rate channel done rigorously, any equity-valuation text on DCF; the duration-of-equities framing is worth searching for in sell-side research, where it is usually explained better than in textbooks.