Interest rates in Australia and the US will, almost certainly, go up over the next couple of years.
Are interest rates increases good or bad for share markets?
The answer to this question seems obvious, right? They are a bad thing. Because the higher the interest rate, the greater the discount rate and the lower the present value of long duration assets like shares – all else being equal.
But as we know all else is not equal.
Using the United States (the world’s dominant economy and share market) as an example, the table below sets out the performance of the S&P500 during the 8 rate hike cycles since the 1970s. The biggest of these interest rate increases took place before 1984 when the Federal Reserve were raising rates to slow runaway inflation. That may be a parallel to today with US inflation currently at around 7%.
During these periods the S&P500 generated an average total return of 23%. Which is pretty good.
Central banks typically raise rates when the economy is firing and businesses are prospering and growing their earnings. Earnings drive share prices. So maybe we shouldn’t be surprised with those outcomes.
We must acknowledge that rising interest rates aren’t the only thing that share markets are contending with right now. No-one knows what returns share markets will deliver during the upcoming rising interest rate cycle. However, history tells us that now is not the time to be sitting on the side-lines.
Let’s hope that the Federal Reserve can effectively reduce inflation to their target rate of 2% without pushing the country into a recession. As a recession would give share markets something else to worry about.
*Thanks to our friends at Ophir Asset Management for preparing and sharing an analysis of this information.
