Why everything you know about investing changes in a rising-rate world

Posted: 3 May 2022 2:31 pm
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For the first time, a generation of investors will need to deal with rising interest rates as central banks around the world battle inflation.

Inflation has all but disappeared over the last decade.

Following the scars of the global financial crisis (GFC), advancements in technology and increasing globalisation, central banks have rarely seen inflation figures above their target range.

But following a combination of supply bottlenecks, armed conflict in the Ukraine and a cash splash from governments to support economies post lockdowns, spikes in inflation have occurred.

This has seen the Reserve Bank of Australia lift rates for the first time since 3 November 2010.

While the first rate rise in a generation might be off putting for some investors, Morningstar Investment Management's equity research strategist Gareth James was quick to calm everyone down, highlighting this is a normal market trend.

"Changes in these rates are likely to impact the market value of assets, such as equity prices and residential real estate," he told Finder.

"However, investors shouldn't be too short-sighted in this regard. Both inflation and interest rates will move up and down over the long-term."

Effect of inflation on markets

Inflation has a double whammy effect on share prices, with the costs of goods and services rising, while at the same time the price of a dollar falls.

As you might've noticed the share market is becoming increasingly aware of the inflation problems, leading to spikes in market volatility. This is because prices are largely based on the expectation of companies' future earnings.

With higher inflation, it erodes the value of a dollar of earnings making it more difficult for the market to price in a fair value for a company's shares.

Adding to that, higher inflation increases the costs for businesses ranging from inventory right through to staff costing, which can become a permanent expense to the business.

The companies you invest in will also have to pay more on their debts as central banks try to slow down inflation through lifting interest rates.

As such, markets fear rising inflation, which will have an impact on returns.

"An entire generation needs to relearn investing"

This rising inflationary world will mean investors will face new challenges they might not have seen before.

Saxo Banks Australian market strategist Jessica Amir warns an entire generation will need to relearn investing.

"US rates could rise more than expected on Wednesday, seeing tech stocks sell off," she said.

Amir points out this is the start of a new cycle with the Fed likely to raise rates by 0.5% for the first time since 2000.

Such a spike will mean investors need to brace themselves for volatility.

"Either way, an entire generation of tech entrepreneurs, and tech investors who built their businesses and investment philosophies on tech, and low interest rates will have to re-learn a thing or two," Amir continues.

Firetrail's head of investment strategy Anthony Doyle told Finder it is extremely difficult to forecast any specific investor's style, instead saying that "every company has a price."

However, he did note growth companies might need to be repriced.

"Growth companies, those companies that have the potential to outperform the overall market over time because of their future potential, were the big winners of 2020 and 2021 after central banks cut interest rates to record low levels and consumers shifted their spending habits," he said.

"With central banks hiking interest rates to stem inflation and economies reopening, these favourable tailwinds have turned."

But long-term investors urged to stay the course

Even in a rising interest rate environment, investors could continue their current strategy.

Doyle points out while it is a challenging time for investors, it could actually be an opportunity to buy.

"One of the best questions you can ask yourself is 'are you a trader or an investor?'"

"For investors, the key is to make sensible, long-term capital allocation decisions, and to stay patient," he explains to Finder.

Doyle highlights "the big money isn't made in the buying and selling." Instead he highlights, "the big money is made in the waiting."

James largely agrees, highlighting it is still a way for you to get ahead.

"The main thing to remember is that equities tend to perform better than other asset classes over the long term, which is why they form the basis of most retirement portfolios. This is unlikely to change, despite relatively high inflation currently," he concludes.

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