RIYADH: The US Federal Reserve’s recent announcements of interest rate hikes in March may have thrown markets to shreds, but that won’t necessarily translate into an immediate medium-term market correction if we consider rely on past cases.
Market experts who have spoken to Arab News say there is evidence that stock prices may rise in the first year of the rise.
“For example, overnight interest rates started to rise in late 2015 before peaking in early 2020 just before the onset of the pandemic. During this period, equity markets strengthened despite rate hikes,” says Ibrahim Bitar, Head of Investments and Treasury at Emirates Investment Bank.
Similarly, he adds, in the 2002 cycle, interest rates began to rise in mid-2004. “Yet the stock market continued to rise until the end of 2007.”
However, Bitar stresses that the pace of rate hikes should be slow and shared with the market in advance.
Historically, when interest rates rise, experts say it’s actually good for equities overall, as long as the hikes are implemented slowly and don’t halt economic growth.
Goldman Sachs’ chief U.S. equity strategist, David Kostin, recently pointed out that the S&P 500 has been “resilient” at the start of Fed hike cycles in the past. He pointed out that despite intimate declines in the first three months, the S&P 500 returned 5% in the six months following the first rate hike in a cycle.
Another Dubai-based analyst points out that despite high inflation figures and clear signals from the Fed, “bond yields remained well contained.”
“While there is a consensus that bond yields could rise gradually, we believe a bond sell-off driven by pandemic-induced inflation is unlikely,” said Patrick McKeegan, vice president and manager of portfolio at Franklin Equity Group, in an interview with Arab News.
The expected tightening of monetary policy by the Federal Reserve and other central banks in response to high inflation nevertheless led to high volatility in stock markets. Fear of a 50 basis point Fed rate hike is one of the factors that has destabilized the market and introduced greater volatility for investors, according to CNBC.
“As of February 9, interest rate markets are priced at more than five 25 basis point hikes by the U.S. central bank in 2022,” Bitar points out.
While higher interest rates can reduce the value of assets. But the question is at what level interest rates rise and after what time the growth of the economy declines and, therefore, negatively affects the value of stocks.
“There is evidence [that] the sensitivity of economies to interest rates increases with higher amounts of debt. The US debt-to-GDP ratio was 138% at the end of 2021, down from 107% in 2019 and 82% in 2009,” Bitar warns.
Given the higher amount of US debt compared to 2019, when US overnight rates were 2.5%, the level of interest rates that will slow the economy in this cycle should be less than 2 .5%, he explains.
As of February 9, 125 basis points of hikes have been priced in the market by the end of 2022. “The question is, would a 1.5% overnight rate slow the economy?” asks he.
The debate around the question remains open on the scene of the capital markets. McKeegan, for example, thinks the market will be muted this year. “The consensus is that once the Fed starts raising rates, markets might start to struggle,” he says.
Survive in uncertain times
Market experts say investors should take several precautions in this uncertain environment. “Investors should control interest rate risk by reducing the duration of their bond portfolios. In addition, investments should be redirected to high-quality, low-risk entities, given the uncertainty of the outlook,” advises Bitar.
Additionally, he points out that investors should avoid illiquid investments which can suffer large drawdowns in times of volatility.
For McKeegan, a growing chorus expresses the belief that “value stocks could lead the way in 2022.” Value stocks refer to shares of a company that appear to be trading at a lower price relative to its dividends, earnings, or sales.
As the experts believe, investing in high-quality companies linked to long-term secular growth can still be profitable because “they perform well over a full market cycle.”
“Looking longer term, we see promising growth opportunities for companies in areas such as cybersecurity, e-commerce, cloud computing and automation,” McKeegan points out.
The expert adds that once the pandemic begins to stabilize, engagement in live events, including socializing, travel and concerts, may return to pre-pandemic levels and allow markets to recover. stabilize.
Regionally, GCC stock markets can be shielded to some extent from international market uncertainty. The GCC stock markets are currently dependent on several factors, including the amount of spending by GCC governments, the price of oil, and US monetary policy, as most GCC currencies are pegged to the dollar.
“The high level of oil helps oil-rich GCC governments to spend. These positive factors are somewhat reflected in valuations,” concludes Bitar.