Have you earned your keep yet?

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The rise in interest on both the short and long term has received a lot of attention. Even on the late news, you are informed that it would be best to buy a house fast, because loans are going to become more expensive. 

What people do not tell you, however, is that the interest rate also influences the asking price of houses. Moreover, higher interest is an effect of growth, and growth also means an improvement of your buying power. 

These issues with interest rates affected the stock exchange in February. America recovers the most, and Europe doubts yet again. The Eurostoxx 600 again distances itself from the 400-point barrier. It is high time that our policy makers improve their promotion of Europe… 

In graph 1, you can see the necative effect of the breakthrough for several indexes. In orde to regain the trust of trend investors, it is important that the old supports, indicated with a red circle, are tamed once more. It is best to keep an eye on those levels!

 

Macro-economics

A company can book great numbers and expectations (= micro-economics), but in case of an unexpected crisis, such as a sudden increase of unemployment, the sales figures go down (= macro-econmoics). Analysts are aware of this, and the expectations of shares are quickly adjusted downward in moments like this. 

Other examples in this framework of macro-economics are:

  • changes in expected international growth;
  • the positive or negative advancement of international relations;
  • unexpected changes in exchange rates;
  • changes in the availability and prices of raw materials;
  • changes in the judicial aspect on delivered products;
  • changes in interest rates!

 

A couple of (theoretical) results of an increase in interest rate:
  • An interest rate increase leads to the movement of assets of shares to bonds
  • Consumption goes down, because the urge to save up increases
  • Companies’ costs of carry increases, which causes profits to decrease
  • The calculated fundamental value of a company decreases, because interest rate is an important parameter with regard to the calculation of valuation models.

You could state that the economic activity and valuation of companies drops in the case of an interest rate rise. This is why you ought to check two elements regularly: 

  • How high is the interest rate
  • What is the current and expected trend

 

How does the stock exchange behave in case of an interest rate increase?

You read a lot about the negative impacts of increases in interest rates. But do not judge too quickly and filter the news. Analyse for yourself and have a look at the following interesting graphs (graph 2), which compares the American Dow Jones stock market index and the Federal Funds Rate*. 

Throughout history, you can also find periods of collective interest and stock market increase or, indeed, decrease. Additionally, we also have known periods where they moved in the opposite direction.

 

Decision

As an investor in shares, always follow the general market trend – as always. If the trend moves upward, stay where you are and enjoy the ride. If the trend turns, calmly get out at the first stop. And the more the trend turns against you, logically, the more shares fall through their support. Raise your cash so you are on the first row when the next upward trend arrives, and hop back on.

Should you wish to live off of the interest, you currently have to have your fingers in a lot of pots to earn your keep… In other words, we are not quite at that level yet!

 

 

*Federal Funds Rate – for connoseur of more theory

Most countries have their own Central Bank and their own interest rate. In the United States, this most prominent interest rate is the Federal Funds Rate. Depending on the economy and the threat of inflation, the FOMC (Federal Open Market Committee), a component of the Federal Reserve System, will raise or lower the interest rate. The market generally is notified in time when such a decision is made; for 2018, investors expect 3 to 4 necessary raises. At least, that was what the latest FOMC meeting concluded.

There are about 8 annual FOMC-meetings. In the United States, the economy performs better, the prices rise, and the FED hits the brakes through a higher interest rate in order to avoid overheating. In essence, there is nothing wrong with that; in fact, performance of the economy improves. 

Banks are obligated to have sufficient reserves (= Federal Funds) at the Federal Reserve. If these reserves are put under pressure, the banks loan at to the Federal Funds Rate (= tariff), from other banks with sufficient reserves.

However, it is not just the loans between banks that increase with an interest rate rise, as the banks will also calculate this increase to their customers. On the one hand, the interest increase will lead to lower economic activity, but at the same time there is MORE economic activity, because otherwise an increase in interest rate would not be necessary… An interest increase is fine, as long as it is not announced rudely and if it is done in time. Investors simply do not like surprises.

Paul Gins
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The trend is your friend

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