Market commentary: Dec 2023
Portfolio performance
The year ended with a roar as international share markets delivered one of their strongest monthly returns as market expectations moved from a “higher interest rates for longer” to a “soft landing for the US economy” outlook. Investors are excited to see that inflation is falling and are therefore expecting interest rates to follow. Lower interest rates mean higher valuations of shares, property, and bond investments. It’s no surprise that our client portfolio returns for the year to 31 December 2023 are looking much better and returns since inception have improved.
Rising interest rates has been the story of the last year so I thought it might be useful to explain why this reduces portfolio returns. It impacts each category of investment differently as you will see below…
Rising interest rates and share valuations
There are 3 primary reasons that share valuations fall when interest rates rise. Firstly, higher rates mean higher interest costs and less profit for companies. Secondly, the value of a company falls as rates rise because the valuation of estimated future earnings reduces. And thirdly, higher interest rates make less risky investments like cash and bonds relatively more attractive.
Rising interest rates and property valuations
When interest rates are low, investors are happy to accept a lower rental return (annual rent as a percentage of the purchase price). But as interest rates rise, they will demand a higher rental return because alternative investments that pay interest have become relatively more attractive. To achieve a rental return that’s comparable with, for example, term deposits means paying a lower purchase price for the property.
Rising interest rates and bond valuations
Bonds pay interest in the same way as term deposits. The difference is bonds can be bought and sold on the secondary bond market and the price changes as interest rates change. In a rising interest rate environment prices of bonds fall. This shows up in portfolios as unrealised losses. These are temporary as they will reverse when bonds mature and the full amount is repaid.
What happens when interest rates fall?
This is positive for all investments and is what investors are desperately looking for at the moment. When rates fall the value of shares, property, and bonds goes up. Hopefully we see this happen in the next few months. Meanwhile we take advantage of high interest rates on term deposits and bonds.
Richard Grimes, CERTIFIED FINANCIAL PLANNER (CFPCM), Director and Financial Adviser