How rising interest rates affect Australian share market prices
For the first time an entire generation of investors is going to experience rising interest rates, but that doesn't mean you need to get out of the share market.
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Special Offer: $385 worth of free brokerage when you transfer your HIN.* Simply transfer your existing HIN before September 30. T&Cs apply. Corporate Authorised Representative No. 1292963 of Sanlam Private Wealth (AFSL No. 337927).
It's no secret the world is battling an inflation problem, which will have an impact on your growth investments.
A spike in commodity prices caused by international conflict, bottlenecks in supply chains, and mass stimulus packages post COVID are all having an impact on inflation.
As such, the United States is now seeing inflation at a 40-year high, sitting at 8.5% while Australia has an inflation rate of 5.1%, which is significantly higher than the 2-3% target range.
All of this is leading to interest rate rises.
The Federal Reserve in the United States on Wednesday, 4 May made the call to lift rates by half a percentage point, its biggest increase since 2000.
Federal Reserve Chair Jerome Powell sent a message directly to the American people, pointing out the current pain inflation is causing them, while pledging to do all he can to bring it down.
Back home, the Reserve Bank of Australia lifted rates for the first time since 3 November 2010, as it looks to slow consumer spending.
Combined, this rising rate environment will put pressure on real asset returns, including share markets and property.
While it could be read as a bleak outlook, does this mean it's time to sell?
To help guide you through this period, Finder, in partnership with GO Markets analyst Lachlan Meakin, explains what a rising rate environment could mean for your portfolio and what you should do next. GO Markets is an Australian-founded broker with an easy-to-use share trading app that currently has a special offer to get $0 brokerage on your next 50 stock trades.
"Don't panic! Rates are still extremely low and the RBA has been doing a good job at preparing the market for these hikes," Meakin said.
"This is a normal part of the economic cycle and rising inflation/interest rates indicate a strong economy."
Impact on the Australian market
Unfortunately for investors who heavily favour growth assets, rising inflation could have an impact on their portfolios.
As the price of business increases due to inflation and rising rates on debt, it has a negative impact on companies' values.
This is especially true for growth stocks.
Rising inflation brings higher rates, which impacts the present value of future cash flows for assets. Assets with a long duration to profitability suddenly become worth less today in a higher rate environment. Given growth stocks earnings will occur years into the future, a change in interest rate impacts them more than value shares.
While the growth focused NASDAQ100 has entered a bear market, falling 20% from its peak, the same impacts are not happening on the ASX200 which is only down 1.34% over the last 6 months.
Meakin highlights,that this is due to the make up of Australia's market, which has more banks and miner focus than its global peers.
"In this environment you would typically see a rotation from growth to value companies which puts the ASX 200 on a good footing against its international peers and I'd expect it will outperform in comparison, especially against growth heavy indexes such as the NASDAQ 100," he explains.
But inflation impacts businesses differently
While inflation will have broad impacts, it does not mean every business will be impacted in the same way.
To highlight this, Meakin shows businesses that theoretically will perform strongly in this environment.
"Typically in an inflationary/rising interest rate environment, companies in the financial, healthcare and consumer staples sectors will outperform," he said.
"With elevated commodity prices we should also see the materials and energy sector do well."
At the same time, there will be sectors that are weaker.
"Companies in the tech, real estate and the consumer discretionary sectors may underperform," he continues.
But even in a theoretically weaker backdrop for businesses Meakin said that "there will still be opportunities in these sectors, they just may need a bit more due diligence."
More: Stay up to date on market movements and events for the day just gone with GO Markets free news and analysis.
Rising rates and the bull market case
While much of the market commentary focuses on the negative of rising inflation on shares, Meakin highlights the positive, that potentially Australian investors could see stronger returns.
This is because a steady rising inflation is actually good for an economy. Having no inflation or deflation means consumers will simply stop buying products.
After all, why buy something today if you can get it cheaper tomorrow?
Meakin points out "the Australian economy is chugging along very nicely with economic figures indicating we are recovering well from the pandemic slowdown."
"Rising inflation shows that demand for goods and services is high and company cash flows should benefit from this."
Advice for those who have never invested during a rate rise
Finally, the market analyst offers some advice for those who are new to this investing world.
While markets will be volatile, Meakin states, "it is never a bad time to start investing, there are always opportunities in any part of the economic cycle, investing for future wealth is the long game."
Instead of delaying entering the market, Meakin highlights the importance of diversification which can potentially see you through a volatile period .
"There will be many investment opportunities in the right companies, the things to look for are strong cash flow and low debt."
"Diversifying your portfolio is also important, don't put all your eggs in one basket," he concludes.
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