Interest rates are rising in the UK. And with inflation approaching 10%, we could easily be in for further hikes in the coming months.
What effect might that have on our investments, and what should we do about it? Are there ways to adjust our strategy to cope with higher interest rates?
Traditional rules of thumb suggest that higher interest rates reduce bond yields and make those less attractive. And they can have a negative impact on the future earnings of companies, especially those that rely on borrowings. So stock prices can suffer.
Rising interest rates also make cash savings more attractive. But most instant access savings accounts are still offering pitifully low interest rates. I saw one the other day boasting that it had lifted its rate from 1.4% to 1.5%. Wow, I’m going to sell all my shares and… well, maybe not.
Investor strategy
An individual investor needs to assess their own needs, their own strategy, and their own investing horizon. I can’t provide that level of guidance. But what I can do is talk about how I plan to adjust my personal strategy to cope with high interest rates.
And I’m not going to change my overall strategy at all. But I do think unusual short-term circumstances like these can provide us with extra opportunities to pick up some good shares on the cheap.
Over in the US, both the S&P 500 and Nasdaq indexes slipped into bear market territory after falling more than 20% from their peaks. Most commentators put this, at least partially, down to rising interest rates. I think there are some nice buying opportunities there now, particularly among tech stocks.
No bears here yet
In the UK, we’ve seen nothing close to a bear market. But then a lot of UK shares have been on low valuations for a long time now. So maybe interest rates are affecting the market simply by holding back any possible recovery.
Negative sentiment tends to afflict the whole stock market, not just those companies that should suffer the most from higher interest. So while companies using a lot of debt funding could be facing extra risk, those with little or no debt should hopefully face less.
I dislike indebted companies anyway. But right now, I’m paying special attention to companies with stronger balance sheets. I reckon those are more likely to be unfairly depressed, and could make better buys at times like these.
Shares boosted
And then there are companies that benefit, rather than suffer, when interest is higher. I’m thinking about lenders, particularly banks. The major FTSE 100 banks have just released first-half results, and they’re looking good. All have been boosted by improved lending margins, and that’s boosted share prices.
So my overall investment approach hasn’t changed. Over the long term, inflation and interest rates will surely even out. And I don’t pay much attention to them when making strategic investment decisions.
But in the short-term, I’ll look to top up my investments in companies that are resistant to debt costs. And I reckon my strategy of avoiding highly-indebted companies provides some safety.