1/13/2021 11:00:00 PM

CIO Report: Interest rates impact valuations


Chief Investment Officer Mark Devcich discusses how interest rates impact valuations.

December again was a strong month for markets following on from the record month of November. This surprised me, given the background of rising interest rates.

Key themes during the month were US dollar weakness, strength of technology stocks with the Nasdaq market being up 5.7% for the month, and small caps outperforming large caps both in Australia and in the US.

We have had a number of impactful news events to end last year and start the new year. These included Brexit negotiations finally concluding, new lockdowns in the UK, Capitol Hill riots and, as mentioned last month, we had the Georgia senate run-off in early January which proved to be a Blue Sweep further paving the way for the Democratic party policies to be passed through the Senate.

Participation in the markets has been strong both from direct retail investors and exchange traded fund (ETF) flows. US ETF inflows was $507B USD in 2020. This breaks 2017’s record ($465B) for the largest year of inflows on record. There are some worrying signs with record number of brokerage accounts being opened globally, and many IPOs coming to market which are increasing more than 100% on their first day after being repriced substantially higher too. We are actively avoiding the euphoric valuations that are prevalent in parts of the market that are trading at nosebleed valuations.

We have seen interest rates move higher which have put pressure on the valuation of growth assets to start the new year. It is difficult to forecast interest rates and we don't attempt to do so, spending more time on trying to predict which businesses will thrive in any environment. However, interest rates act as a gravitational pull on valuations. The higher they are, theoretically, the lower valuations should be and the stronger the pull is on growth companies whose earnings are expected to be more weighted to future years.

Overall equities still look attractively priced compared to the alternatives of bonds, property and cash. This year we should see a substantial rebound in economic growth and consumers balance sheets are well replenished after a year of saving more than normal, providing an environment for us to continue to find fruitful opportunities to deploy capital.

Past performance is not an indicator for future performance. This is not intended to be financial advice and does not take into account any particular person’s circumstances. Before relying on this information, please speak to an independent financial adviser.