E1 Asset Management Ask: How Rising Interest Rates Will Affect the Stock Market
JERSEY CITY, NEW JERSEY, USA, December 27, 2021 /EINPresswire.com/ – Amid rapidly rising inflationary concerns, the Federal Reserve last week announced plans to raise interest rates to three times in 2022. The first rate hike could come as early as March. While the decision to raise interest rates will help align inflation, many investors are concerned about how higher rates could affect their portfolios. Here’s what investors need to know about the impact of higher interest rates on the stock market and what to expect by 2022.
How stocks react to higher interest rates
Typically, rising interest rates hamper stock market growth, as higher borrowing costs cause businesses and consumers to spend less. This decrease in expenses can include fewer hires, lower productivity and reduced income. In turn, these effects usually cause stock prices to fall or plateau.
Another important consideration is that small changes in interest rates can have disproportionate effects on stock prices. This result occurs because most of the price of a given stock is based on the terminal value, or the value for the period beyond which profits can be reliably predicted. When the price of the loan increases, the long-term costs to businesses increase dramatically and reduce the projected terminal values of the stocks.
Could 2022 be the exception?
While rising interest rates put downward pressure on stock prices, many other factors come into play. With the US and global economies currently in the midst of strong recoveries supporting rising stock prices, the fourth quarter is now expected to see economic growth well above what economists had expected. In addition, the United States could also move closer to full employment, suggesting that lower interest rates are no longer needed to stimulate hiring.
Also consider that interest rates have been kept near zero in recent years. Even with the next rate hikes, US interest rates will remain relatively low by historical standards. According to an analysis by investment giant BlackRock, stock prices are historically more likely to rise than fall when interest rates rise from abnormally low levels. If this trend continues, the three interest rate hikes in 2022 are unlikely to significantly affect stock prices.
What to expect from the stock market next year
Given the uncertainty over the impact of rate hikes on stock prices, several outcomes are possible for 2022. First, some analysts, including those at Morgan Stanley, expect high levels of growth to continue, even though interest rates rise. Continued growth would be in line with BlackRock’s conclusions regarding hikes in low interest rate environments, especially if the rate hikes are each small enough. In addition, some interest rate increases are likely already built into the market, reducing the risk of sudden price drops.
Another school of thought, however, takes the more traditional point of view. Under this model, stocks would level off and remain broadly stable throughout 2022, as growth stabilizes and interest rates rise. This model is more consistent with the prevailing view of an inverse relationship between stock prices and interest rates.
Another projection suggests that stock prices will collapse long after the rate hikes take effect. Based on data from historic rate hike cycles, analysts at Deutsche Bank estimate that stock prices may continue to rise for about 10 months after the first hike. If this pattern is correct, stock prices will not start to slow until early 2023.
How to protect your portfolio from interest rate hikes
While no one can predict exactly what will happen when interest rates rise, there are some strategies that can help investors isolate their portfolios. One of these approaches is to find companies that are likely to benefit from the higher rates. For example, utility stocks tend to underperform when rates rise, but industries that earn interest on loans can still do quite well. Financial stocks, for example, tend to be well positioned to benefit from higher interest rates.
Investors can also adjust their bond holdings to protect against high interest rates. A mix of corporate and government bonds will help you weather the storm of higher rates. If investors’ fixed income investments are in funds, look at the makeup of those funds to make sure they are well diversified.
Finally, investors should consider divesting assets used as inflation hedges. Tangible assets, especially gold, are useful hedges against rapid inflation. However, these assets tend to perform poorly when interest rates rise. Selling some of their inflation hedges and allocating capital to other assets can help their portfolio as a whole maintain its performance in a high interest rate environment.
The Federal Reserve’s decision to raise interest rates in 2022 may be bad news for the stock market, but there are still opportunities for investors. Above all, make sure you continue to put money into their investment portfolio on a regular basis. The simple dollar cost averaging strategy is a great way to build long-term wealth, even if short-term price declines or plateau do occur. Staying consistent with their investments will allow investors to weather the temporary effects of rising interest rates in 2022 and beyond.
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