America's biggest companies have been turning in strong quarterly profits, led by the artificial intelligence giants that have powered much of the market's recent gains. But with interest rates climbing and inflation refusing to fade, even stellar results may not be enough to keep stocks rising.
The last of the so-called Magnificent Seven still to report, Nvidia, is due to reveal its latest numbers on November 17th. That will be a key test for the AI trade that has driven much of the market's momentum. Yet investors may want to look further back for a more important lesson—one from the 1970s that could help protect portfolios today.
The gravity of interest rates
During the 1970s, the US economy kept growing, but stocks went practically nowhere for years. Even shares in great businesses suffered. The culprit, according to Warren Buffett, was simple: interest rates are gravity.
Buffett's metaphor is a useful one. When interest rates are low, money is cheap, and investors are willing to pay more for future earnings. That lifts stock prices. When rates rise, the opposite happens: the present value of those future earnings falls, and stocks become less attractive relative to safer assets like bonds.
In the 1970s, rates climbed sharply as the Federal Reserve fought double-digit inflation. The result was a long stretch of flat or falling stock prices, even as corporate profits grew. The lesson is that earnings matter, but the discount rate—the rate used to value those earnings—matters just as much.
Today, rates are climbing again. The Federal Reserve has been raising its benchmark rate to combat inflation that has proven stickier than many hoped. Recent data showing hotter-than-expected inflation has revived bets on further hikes, a trend visible in markets from Saudi stocks to UAE markets.
Strong earnings, but a heavy weight
So far, the earnings picture has been bright. Companies across sectors have beaten expectations, and the AI boom has fueled outsized profit growth at the biggest tech firms. But the market's reaction to those results has been mixed, with some stocks falling despite good numbers.
That disconnect is a classic sign that rates are starting to bite. When investors demand higher returns to compensate for higher rates, they become less willing to pay premium prices for stocks, even those with strong growth. The AI trade, which has been a major driver of market gains, could be especially vulnerable if rates keep climbing.
Nvidia's upcoming report will be a crucial test. As the poster child for AI, its results and outlook could set the tone for the entire sector. But even a blowout quarter may not be enough to overcome the gravitational pull of higher rates.
What it means for investors
For everyday investors, the 1970s offer a cautionary tale. It's possible to have a growing economy and rising profits, yet still see your portfolio go nowhere for years. That's because interest rates, not just earnings, drive market returns.
This doesn't mean you should abandon stocks. But it does suggest that diversification and a focus on quality—companies with strong balance sheets and pricing power—can help weather a period of rising rates. It also means being prepared for volatility, especially in high-growth sectors that are most sensitive to rate changes.
Investors should also watch the bond market. As rates rise, bond yields become more competitive with stocks, and that can pull money out of equities. The recent easing in mortgage rates offers a small counterpoint, but the broader trend is upward.
The lesson from the 1970s is not that stocks are doomed, but that they face a heavier headwind. With rates climbing and inflation stubborn, even great earnings may not be enough to keep the market aloft. Keeping your feet on the ground—and your portfolio diversified—might be the wisest move.
