The past year has seen inflation at levels unparalleled for decades.
While the causes of this are many and complex, the result has been the same across developed markets with central banks raising interest rates in an effort to prevent the price rises becoming a longer-term feature of the economy.
In the US, rates have risen further and faster than in the UK, and the Federal Reserve has raised the base rate by 0.75 percentage points at three consecutive meetings, with markets pricing in another similar rise in early November.
Key for investors is being aware that rising interest rates mean future cash flows are given a lower value by the market today – this hits almost all companies but has a particularly acute impact on companies such as start-ups, which may not have strong cash flows for many years.
Although expected earnings for the S&P 500 have increased from $223 (£193) at the start of the year to roughly $235 currently, interest rates have hampered the overall outlook, says Eric Papesh, portfolio specialist for US equities at T Rowe Price.
“Interest rates have increased meaningfully and as a result, we’ve seen the price-to-earnings multiple contract from 21 times to 16 times today,” he says.
Ron Temple, head of US equity at Lazard Asset Management, says he is increasingly optimistic that now is a time when investors should be thinking about what to buy, as opposed to what to sell.
"[Investors] should be thinking about what high-quality companies to buy now that in two to three years they will be very happy to have purchased," he says.
While it is harder to quantify, rising rates increase the cost of financing for the big-ticket consumer items such as cars, and housing, reducing demand for them, Papesh says.
“On the positive side, higher rates are typically associated with better levels of profitability for banks and insurance companies, depending on which rates are increasing and the overall steepness of the yield curve."
The financial sector is always touted as being a beneficiary of high interest rates, as they charge higher rates on loans without having to pay their depositors as high a rate.
Papesh says he is seeing strong growth in net interest income in US banks on the back of these higher rates, and capital ratios have improved “dramatically” over the past decade.
“Loan growth, at least so far, remains healthy,” he notes.
However, when investing in banks, it is important to watch credit conditions, warns David Harrison, manager of the Rathbones Greenbank Global Sustainability Fund.
“At the moment they are OK in the US, the job market is strong, and [households are] still running down some of the Covid savings, but I think [investors should] keep a close eye on next year.”
