Opinion
How to navigate the sharemarket when interest rates are rising
By Michael Gable
The Australian sharemarket has essentially made no progress this financial year. It is doing it tough and sentiment has turned for the worst.
We have moved from a market where buying the dips and being supported by central banks was a winning strategy, to one where selling into rallies is the most prudent way to keep your head above water.
Equity markets have been sliding since the start of this yearCredit:Louie Douvis
Why is this happening? A major reason for the bearishness lies with central banks.
Due to inflationary pressures, the banks need to raise interest rates and wind back their quantitative easing, which effectively flooded the market with cheap money.
It is not as though equity markets were not warned of this impending liquidity issue. US bond yields started leaping higher in the final quarter of 2021.
Eventually, reality caught up, and equity markets have been sliding since the start of this year.
Interest rate rises make stocks look more expensive. A pullback in share prices was inevitable.
High-valuation stocks, such as technology companies, are under pressure, especially those without positive cash flow. To make things worse, this year has seen the war in Ukraine, and COVID lockdowns in China. Sharemarkets globally are now starting to price in the possibility of a recession.
The past few months have provided a good lesson to investors that company earnings are not the sole determinant of share prices. A large portion in the past few years has been the result of low interest rates.
As central banks raise rates and undergo quantitative tightening, market liquidity and valuations turn around and start deflating.
As inflation picks up, it is commodity prices, and therefore commodity stocks, which are increasing in value. This is why the Australian sharemarket is holding up better than US markets.
US markets outperformed our equity market for a number of years because of a high number of tech companies in their benchmark indices. Now, this is proving to be a double-edged sword as the tech shares weigh down the US market, while resource stocks support our local market.
The market is forward-looking and, right now, the risk is still to the downside. Although price-to-earnings ratios have fallen back, there could still be further for these to fall.
When I use technical analysis to observe share price behaviour, I am still not seeing any panic selling.
There is still some buying on individual equity dips, despite there being some selling on rallies.
Still, there is a good chance that in the weeks ahead we could see markets fall by another 10 per cent, as retail investors give up and head for the exits. Whether that happens, or not, sharemarkets will likely continue to struggle.
With commodity stocks now likely to take the mantle as the strongest market sector, I anticipate some good opportunities for those who can trade their massive swings. Time-frames for investments need to be lowered and investors must be more active.
I can also see plenty of blue-chip companies that are trading well below their peaks from 15 years ago.
Having said all this, there is still potential for sharemarkets to surprise to the upside. The catalyst for this would be a change in the outlook of interest rates. Central banks are talking tough on inflation, and markets are pricing in quite a few rate rises from here.
However, if central banks were to pause on rate rises earlier than expected, that would put a rocket under share prices – for a while.
- Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. They should always seek their own professional advice that takes into account their own personal circumstances before making any financial decisions.
Michael Gable is managing director of Fairmont Equities