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Are Higher Interest Rates Good For Shares?

Have you ever noticed how it can be raining in one part of Singapore but not in another?

It’s not as though Singapore is that big an island. We, after all, only measure 270 square miles.

But have you ever noticed how it can be bucketing down in Little India but it could be as dry as a bone in Orchard, which is only a couple of miles away.

That’s not the weirdest thing that I have ever noticed, though.

I recall once walking over from Bukit Timah Road to Dunearn Road. The people on one side of the canal were sheltering from the rain, while the pedestrians on the opposite side were bathed in sunshine.

Unusual phenomenon

How strange. It can’t be more than a couple of hundred yards from one side of the road to the other.

Now, I am no meteorologist. But I am pretty certain that weathermen have a perfectly good explanation for the phenomenon.

I am, however, a stock-market analyst. And I can’t help but notice some interesting similarities between the unusual weather phenomena and some of the more curious things that can happen in the stock market.

For example, when storm clouds appear over the market, not all shares could be affected in the same way.

Dependable returns

For instance, if interest rates are expected to rise, it is generally expected to be bad news for the stock market. That is kind of understandable.

If interest rates go up, then investors could, theoretically, earn more dependable returns from deposit accounts than, say, something riskier such as shares.

So, the immediate response to an interest-rate hike tends to be to sell shares and put the money in the bank. In other words stock prices could fall.

But not all companies could be adversely affected by rising rates. Real Estate Investment Trusts (REITs) are a case in point.

Hasty conclusions

Many people think that higher borrowing costs could disproportionately hurt these indebted companies. And they would be right… but only up to a point.

Rising interest rates could mean that they spend more money servicing their loans, rather than pay out as distributions to shareholders.

But it is important not to jump to hasty conclusions.

A rate rise could, for instance, indicate that the economy is improving. So, that could imply some companies might even grow their profits more quickly. REITs, for example, might use the opportunity to increase rents.

Higher profits

So, faster economic growth could mean higher profit. So, we should be prepared to pay more for every dollar of profit that those companies make.

Some companies, especially banks, might even benefit disproportionately from higher interest rates. A rate hike could mean that banks might, arguably, charge more for loans.

Consequently, the difference between the money that banks make from lending compared to the money that they have to pay on deposits could widen. That could benefit banks, significantly.

So, when we invest, it is important to know as much as possible about the types of companies that we choose to own shares in.

Dangerous generalisations

It can be quite dangerous to generalise about how the stock market could react to events, such as, say, an increase in interest rates. But many do.

And that could work to our advantage.

If we want to do well from the stock market, we need to think differently. We have to go into places where other investors fear to tread. We have to go where it is raining.

We pay a high price for a sunny outlook.

So, when rain clouds appear over the market, it could be our cue to look for stocks to buy rather than follow the crowd and sell.

In my book, anyone who says sunshine brings happiness has never danced in the rain.

We at Stock Advisor Singapore are always looking for opportunities to dance in the rain. You can see what I mean here.

A version of this article first appeared in Take Stock Singapore. Click here now  for your FREE subscription to Take Stock – Singapore, The Motley Fool’s free investing newsletter.

Written by David Kuo, Take Stock - Singapore tells you exactly what's happening in today's markets, and shows how you can GROW your wealth in the years ahead.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.