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Should investors be worried about rising interest rates?

12 March 2018

It’s far from time to head for the exits, says Colin McLean, managing director, SVM Asset Management

Welcome news for savers with cash in the bank can be a warning of challenges ahead for shares and bonds.

While it’s a time to be more aware of the risks in shares, it may not yet signal the end of the economic cycle. Global growth remains robust and there’s little sign that inflation is out of control.

So, rather than running for the exit, investors need to think carefully about their portfolio focus.

Sharp market falls are painful, but also create opportunity. There are winning and losing businesses at all stages of the economic cycle.

However, the shift in inflation expectations should concern investors in bonds and gilts. The last 10 years have been extraordinary for monetary policy and central banks are moving back towards more normal behaviour.

Bond investors may have been lulled into a false sense of security. Some governments and companies have been able to borrow on unrealistic terms that don’t seem to recognise their credit history.

The role of bonds in a portfolio is to provide resilience, but in the financial crisis many behaved much like equities. The search for yield in recent years has driven many investors into riskier or less liquid assets.

Bursting bubbles in Bitcoin and other crypto-currencies should prove healthy for stock markets. Speculators had also been drawn to some esoteric investment products, betting on investor complacency and low stock market volatility. Fortunately that speculation has ended before becoming too widespread.

These shocks are a reminder that there are dangers in many complex financial instruments and that company profits and dividends matter. For companies that have yet to move into profitability, it’s important that business targets continue to be met. Higher interest rates create a headwind for attracting further finance.

It’s likely that some businesses dependent on UK consumer confidence will disappoint this year. Consumer credit is stretched, with little room to borrow more and there may be risks in consumer-oriented, cyclical and low-margin businesses. The relentless rise in internet shopping means that many high-street retailers are struggling.

Indeed, a range of sectors are being disrupted by new entrants. This is not just driven by new technology, but a change in tastes that favours experiences over things.

Investor nervousness means that any companies that disappoint are being punished severely. Sharp share price falls are likely to follow any disappointment in earnings as investors radically revise expectations.

Higher interest rates may also challenge shares propped up solely by dividend yield, with little real growth. Investors must also factor-in politics, which has already hit utilities and transport.

Stock markets may be more volatile this year, but longer term investors should view this as opportunity.