How to Trade Rising Interest Rates - The Solihull Observer

How to Trade Rising Interest Rates

Solihull Editorial 9th Feb, 2023 Updated: 13th Feb, 2023   0

It was recently unveiled that the Bank of England (BoE) had once again initiated an interest rate hike, lifting this by 0.5 percentage points to a 14-year high of four per cent.

Two of the Bank’s members argued against the rate hike, suggesting that the previous increases had yet to feed through and impact the economy.

Similarly, they raised concerns that the hike would further the pressure placed on home and business owners, with interest rates in the UK now highest among all G7 economies.

From an investor perspective, however, interest rates represent just another macroeconomic hurdle that must be negated in the quest to achieve a profit. But what are the best ways of achieving this and trading interest rate hikes in 2023?




Interest Rates – A Brief Introduction

Interest rates describe the proportion of a loan that’s charged as interest to borrowers, while lenders will build and adjust their rates according to the base rate set by the BoE.

The base rate is also a constant and seminal macroeconomic driver, and one that impacts investors in a number of different ways.


In addition to countering inflation and raising business borrowing costs (which can in turn devalue specific stocks and equities), it also directly impacts currency valuations.

More specifically, rising interest rates theoretically cause currency values and capital inflows to increase, whereas valuations will depreciate as the base rate is lowered.

Because of these factors, interest rates are a prominent and influential factor that investors consider when creating or rebalancing their portfolios.

 

How to Trade Rising Interest Rates

The question that remains, of course, is how exactly can investors look to trade rising or inflated interest rates and profit in the current macroeconomic climate? Here are some options and asset classes to keep in mind:

#1. Invest in Banks and Brokerage Firms

There remains considerable cynicism around the raising of base rates, primarily because banks and brokerage firms earn money from interest.

As a result, banks and lenders are able to earn more when the rates are higher, helping to account for the fact that it’s typically harder to borrow cash during times of economic contraction as credit isn’t as readily available.

Historically, financial services firms such as banks and brokerages have seen improved performance when base rates are increased, particularly from the perspective of interest income and operating profit margins.

Of course, it can be argued that banks and brokerage also thrive when interest rates are low, as they’re able to benefit from the interest earned in larger volumes through increased consumer spending. This simply reflects the free market model of capitalism prevalent in nations such as the US and UK, which makes financial services entities of this type highly valuable.

So, you can definitely leverage interest rate hikes by investing in banking and financial services stocks, especially larger and commercial banks and brokers.

#2. Invest in Cash-Rich Companies

It’s definitely worth learning how to buy shares and trade them in the current economic climate, with cash-rich companies also offering a viable option as interest rates continue to rise.

Such businesses tend to benefit from rising rates because they earn considerably more on their cash reserves and savings. At the same time, cash holdings are incredibly liquid and can quickly be converted into alternative assets, so such firms are well-placed to adjust their portfolios as the economic landscape shifts.

If you want to invest in this type of firm, we’d recommend looking for companies with relatively low debt-to-equity (D/E) ratios or businesses with large percentages of book value in the form of cash.

There are also international assets of this type that are known to hoard cash in an array of different currencies, such as smartphone giant Apple.

During the final quarter of 2021, Apple held a staggering $63.91billion in cash on its balance sheet, earmarking the equity as a potentially lucrative option for investors this year.

#3. Invest in Technology and Healthcare Stocks

We’ll close with leading technology and healthcare stocks, which typically tend to outperform the market and indexes such as the S&P during periods of recession or economic downturn.

Characterised by major, large-cap stocks, tech and healthcare equities also tend to hold on to higher amounts of profit as retained earnings. This capital is subsequently reinvested into business and market growth opportunities, rather than being paid out as dividends to shareholders.

Tech stocks may be a particularly attractive option at present due to their recent devaluation, which came as brands including Meta (formerly Facebook), Google and Microsoft saw their earnings (and subsequent equity value) plummet.

More specifically, you can buy into big tech stocks at a discounted price, whether you’re able to procure full or fractional shares. This can lead to more sustained gains in the near and medium-term, particularly as the leading tech brands rebound and benefit from sustained investment.

The Last Word

While the current economic climate is far from positive (especially from the perspective of home and business owners), there remain ample opportunities for investors to thrive against a backdrop of rampant inflation and high interest rates.

As a general rule, it’s financial service brands that are most advantageous to investors when interest rates rise, as banks, brokers and similar entities benefit directly when the base rate rises.

Large cap tech and healthcare stocks may also offer value at present, while seeking out cash-rich brands also minimises your exposure to risk for as long as the base rate remains high.

Article written by Sarah Sidney.

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