Shares and interest rates go hand in hand

Aug 16 2017 13:28
Schalk Louw

So many things in our daily lives go hand in hand, whether it’s sunshine and summer, tea and biscuits or Hashim Amla and centuries.

When we take a closer look at our stock market and interest rates, we will note that even these two go hand in hand.   

On 20 July, the South African Reserve Bank (SARB) announced its decision to, for the first time in five years, lower interest rates by 0.25 percentage points. 

This decision follows after local GDP showed negative growth for two quarters in a row – something that plunged us right back into a full-blown recession. 

Although the interest rate cut may not be a huge saving for the average South African consumer, the message that the SARB is trying to send is very positive, namely it’s attempting to stimulate growth.
However, the question of how this will affect local shares now that we find ourselves in a declining interest rate phase remains. 

In an attempt to answer this question, I would like to refer to the period since 1973 as an example (please note that historical figures do not guarantee future performance in any way whatsoever).
The period during which interest rates start to rise from a low up to where they start to drop again, is called a rising interest rate phase. 

When interest rates drop from a high to a low, the period up to the point where they start to rise again is known as a declining interest rate phase. 

What’s interesting about this 44-year period is that interest rates rose 48% of the time and declined 52% of the time, which nearly gives us a 50/50 scenario.
Even more interesting is the duration of each of these phases. Each one didn’t last only for a month or two – an average rising phase lasted 34 months over this period, while an average declining phase lasted 32 months over the same period.
When we take a look at our stock market over the same period, it is quite striking that we have never experienced a negative market in a declining interest rate phase since 1973. 

Quite to the contrary, the market flourished.   

The average annual growth during a declining interest rate phase over this period was a whopping 34%, while you would only have earned around 0.9% annual growth in a rising interest rate phase. 

Looking at the performance over the various periods, it is clear that you would have outperformed the money market in every declining phase, while you wouldn’t have been able to outperform the money market in a rising phase.
What’s remarkable about this theory is that if you had invested R100 in shares in March 1986 and had withdrawn all dividends, it would have been worth R3 916 as at 30 June 2017, compared to R2 099 in a money-market investment. 

If you, however, invested that same R100 in shares alone in a declining interest rate phase and then took refuge in the money market during a rising interest rate phase, your investment would be worth R14 120 as at 30 June.
I would like to reiterate that these historical figures bear no guarantees for future performance in any way, but what we can learn from this, is that it is never wise to put all your eggs in one basket. 

According to successful investors like Warren Buffett, the best holding period for shares is forever, so I’m definitely not saying that investors should jump from shares to any other asset class simply based on interest rate cycles. 

What you should know is that as from 20 July, we entered a declining interest rate phase, and although none of the “corrections” followed shortly after any of the phase changes, I definitely wouldn’t have too much of a negative outlook on local shares anymore.
Will this time be different? That’s what many investors thought in the prior declining phase (2008 to 2013) after markets declined even further at the start of the phase, only to end that phase at a fantastic annual growth rate of 22%. 

So, whether you believe in historical figures or not, shares and interest rates clearly go hand in hand, and the recent interest rate cut is definitely leaning towards a more favourable environment for equity investments.

Schalk Louw is a portfolio manager at PSG Wealth.

This article originally appeared in the 10 August edition of finweekBuy and download the magazine here.

equities  |  investment  |  interest rates  |  jse  |  money market