Are slightly higher US interest rates really all that bad?

PaulRen's picture

From a member posting in our active lounge:

Paul, normally gradually increasing interest rates is incompatible with rising share prices. I fail to follow your logic?

Great question/comment. Perhaps in time some could say, I hope to say, the annual membership contribution is to some worth just understanding this.  Which obviously so many don't.  So here I go:

Interest rates remain historically very low, here as around most of the world.
Even as they tick up a bit, they are bouncing  from such a low bottom, that its hardly alarming. (In Thailand the offical interest rate even dropped a notch further of late, even while the Banks did not follow).  Interest rates are creeping up a bit in the US because the economy is showing some strenght, at least based on official figures and more then in the very lethargic past. Stronger economic activity there  (primarily consumer and housing for now) increases company profits as the economy is well, stronger. Stronger corporate profits on increased econmic activity increases share prices -more so then a slight increase in % rates to a certain point.  Also bonds go into a bear market now as bonds are very interest rate sensitive and don't benefit from higher profits, as these just pay their stated interest coupons.  There is far more money in bonds then stocks, so where will all the huge capital from selling bonds go to?  Gold, Oil, commodities ?...little for now it seems.  Mega sums, far more then stocks, are in the world bond markets.

In the early and then mid 1990's, interest rates where triple or more here in Thailand, as compared to now.  Many rightly boasted how they got 11-13% returns on their 6 month Bank deposits. KBANK's 10 year bond yielded around or more then 11% vs. now less then half!  Yet, p/e ratio's where higher then, as to now!  Go figure. I think in those days the p/e peaked well above 20 vs. now, the SET just reports the current p/e to be 14-15 and many are less.  DEMCO's p/e has dropped to 9-10, before dillution and its a SET100 stock.   To be fair, in those days the economy grew faster then the current 4-5% but there were far less savings to be invested.  Gross National Income per capita, more then trippled since.

Point being that % are still at near record lows, that huge bond money will divert out and into something else in time, more like stocks. Cash is less attractive with all that money printing going on (!), and not least:  interest rates are ratching up some because, still the World's largest economy, is doing a bit better, a good thing if you own stocks which need earnings growth to commend decent p/e ratio's. To balance, China is slowing down a bit but 7% but this is still impressive. And Japan, #3 economically, is pumping liquidity and so coming up, not least due to massive Yen devaluation.

My take is that its the dominant index funds which want to show least exposure to stocks by their mid year report especially soin emerging markets, which made the headlines of the sell-off in recent weeks.  Once the end of this weeks comes around -end of June- they will come back to their senses and in time this will be seen as just a correction.  More like now is an ousttanding buy opportunity to the strict longer term value investor and we here know and unserstand where to look!  Time will tell.

Best Regards,

Paul A. Renaud.