I have referred to the correlation, or lack thereof, between quite a few ratios and investments in my past writings. But much like Australian Cricket players and sandpaper, when we take a closer look at the relationship between our stock market and interest rate cycles, you will see that these two do in fact go hand in hand.
On Thursday, the 18th of July 2019, the South African Reserve Bank (SARB) lowered interest rates for the first time since March 2018 by 0.25%. Although we did see a 0.25% interest rate increase in November last year, general consensus is that we most likely never needed that increase. With that being water under the bridge, however, we now find interest rates back to levels before this increase took place and the general feeling is that this may not actually be the last interest rate decrease we’ll see in 2019.
What we would like to know now, is if interest rates decline even further, how will it affect our local shares? Let’s refer to the period between 1973 and now as an example, bearing in mind that the past in no way guarantees any future movements:
The period during which interest rates begin 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 begin to rise again is known as a declining interest rate phase. What’s interesting about this almost 46-year period, is that interest rates were rising about 51% of the time, and declining around 49% of the time. This is very close to a 50/50 scenario.
Even more interesting is the duration of these phases. They didn’t only last for a month or two. An average rising phase lasted for 31 months over this period, while an average declining phase lasted for 32 months.
When we look at the stock market during these phases, it’s quite striking that we never saw a negative market during a declining interest rate phase since 1973. On the contrary, the market flourished.
The average growth during a declining interest rate phase over this period was an incredible 29.5% per year, while you only would have earned an average of 0.9% growth per year during the rising interest rate phases.
The remarkable thing about this theory is that if you had invested R100 only in shares in March 1986 and you withdrew all dividends, your investment would be worth R4 416 today, compared to R2 388 (before tax) in a money market investment. But if you invested only in shares during a declining interest rate phase and then took refuge in money market during a rising interest rate phase, your R100 original investment would be worth a staggering R14 961 today.
Again, I would like to point out that the past bears no guarantees for future performance, and in light of this, I need to make it clear that it is never a good idea to place all your eggs in one basket. I am also not trying to encourage you in trying to time the market. What this does show, however, is that often when investors are ready to give up on the stock market, may in fact be the best time to invest.
Just know that South African companies have had a very tough time over the last five years and in the process, have managed to position themselves very cost-effectively. With interest rates back to lower levels, there certainly is reason for optimism.
Will this time be different? Will this be the last interest rate decrease South Africans will see in 2019? Are shares priced exorbitantly at current levels following the past seven month’s positive run? To answer all three of these questions, I think not. But whether you believe in historical movements or not, the correlation between shares and interest rates cannot be denied.
The opinions expressed in this blog are the opinions of the writer and not necessarily those of PSG. These opinions do not constitute advice. This is intended as general information and does not form part of any financial, tax, legal or investment related advice. Although the utmost care has been taken in the research and preparation of this blog, no responsibility can be taken for actions taken based on the information contained in this blog. Since individual needs and risk profiles differ, it is always advisable to consult a qualified financial adviser before taking action.