Shares and interest rates go hand in hand

Like cheese and wine; tea and biscuits; Sonny and Cher; and Bismarck and a disciplinary hearing, the equity market and interest rate cycles also go hand in hand.

On 2 June, the Reserve Bank reported that lowering interest rates may be a thing of the past (for now). They feel that a moderate strengthening of the monetary policy should help to keep inflation in check while not having too great an effect on economic growth.

Now the big question: if interest rates do rise, how will it affect local share prices? Without using historical figures as a prediction for the future, we can use the period from 1973 onwards as an example.

What’s interesting about these past 42 years is the fact that interest rates rose 48% of the time, and declined 52% of the time – close to a 50/50 scenario. Even more interesting is the duration of these phases. The average rising phase during this period lasted for 31 months, while the average declining phase lasted for 32 months.

When we consider the equity markets during these phases, it is quite striking that we never saw a negative market during a declining interest rate phase since 1973. On the contrary, the market bloomed like the Namaqualand in spring.

The average growth during a declining interest rate phase was a staggering 36% per year, while you would have only earned 0.5% growth on your capital during a rising interest rate phase. The four graphs clearly show that you would have outperformed the money market during the past six declining interest rate phases (1994-present), while this would not have been possible during a rising interest rate phase.

What’s remarkable about this theory is that if you invested R100 in shares only in March 1986, your R100 would be worth R3 966 today, compared to the R1 837 before tax you would have had if you invested in the money market. If you had only invested in shares during a declining interest rate phase and took refuge in the money market during a rising interest rate phase, your R100 would be worth a whopping R12 357 today.

At this point, I need to reiterate the fact that the past serves as no promise for future performance.

This is an excerpt from an article that originally appeared in the 18 June 2015 edition of finweek. Buy and download the magazine here.