Not all asset classes are affected negatively from interest rate rises. In this article we list the various asset classes and how rate rises affect them.

Cash

People holding cash are positively impacted by rate rises as it means the interest rate they earn on cash in their bank account increases. Banks usually increase their interest rate on savings accounts when the cash rate rises. Interest rates offered on term deposits are also lifted, which is a positive people who want to lock their cash into a term deposit.

Bonds

Higher interest rates are a negative for existing bond holders as it means lower bond prices.

The reason why bond prices decrease as bond yields rise can be demonstrated by this example. If a 10 year corporate bond is issued with a coupon rate of 3% and you invested $1000 you would get interest of $30 a year ($1000*0.03).  If a year later interest rates rise and the same company issues a new bond with a interest rate of 5% then the new bond holders can receive an interest payment of $50 ($1000*0.05). The bondholder of the 3% bond will find it difficult to sell the bond in the market when new bonds issued are paying 5%. Hence the 3% bond holder will need to decrease their bond price to make up for the difference in interest payments. If the 3% bond is sold then the new owner will earn 3% in interest as well as some capital appreciation from the reduced bond price.

As you can see in the above example bond holders have to sell their bonds at a discount if interest rates rise and investors can get a better yield from newer issued bonds.

Property

Investors with property will find mortgage payments increase as interest rates are raised. Higher rates will reduce the borrowing capacity for home buyers which means buyers will have less funds to bid with when purchasing property. If interest rates continue to be hiked, homeowners may struggle to make mortgage repayments and be forced to sell at market price. If they bought at a higher purchase price compared to current market value, then they will be selling the property at a loss.

Shares

In general, when interest rates are cut then this causes the market to go up. When the interest rates are lifted, the stock market could go down. The main reason for this is that companies will have less capacity to borrow more from the banks and less to spend on their business to boost growth. This in affects their earnings and then their stock price.  Companies in consumer discretionary sector will be impacted in a higher interest rates environment as consumers may cut back on spending on discretionary spending so these companies may see a slowdown in sales. Not only that, but the present value calculations of future earnings for stocks are affected by interest rate assumptions. Higher interest rate assumptions reduces the present value of future earnings. This means that a share price that seemed acceptable at low rates is now too high under higher rates. Therefore stock prices coming under more pressure.

Lauren Hua is a private client adviser at Fairmont Equities.

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