Interest rates hit 5%! Here’s a rare opportunity in the stock market

Jon Smith explains in detail why higher interest rates are presenting a small pocket of opportunity in the stock market right now.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Chalkboard representation of risk versus reward on a pair of scales

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The Bank of England released the latest interest rate decision at midday on 22 June. The committee decided to raise the base rate from 4.5% to 5%. The initial reaction from the stock market has been a knee-jerk lower. In fact, the FTSE 100 is now down 1% on the day, sliding below 7,500 points. Despite what may seem lots of doom and gloom, I feel it presents a rare opportunity right now.

Why high rates are bad for the market

Interest rates in the UK are now at the highest level in decades. The hikes act as a negative impact on stocks. The vast majority of companies have some form of debt. This could be in the form of bank loans, bonds or other borrowings. Ultimately, the rate of interest that the firm has to pay on this debt is broadly linked to the base rate. With higher rates, it makes it more expensive for the company to issue new debt.

For businesses that sell directly to consumers, high interest rates present another problem. The squeeze on disposable income has hit people hard. With inflation making it more expensive to live, higher rates (meant to bring down inflation) currently aren’t working that well. Naturally, consumers are going to cut back on spending, something that’s already been seen this year. This reduces revenue for the businesses and puts pressure on the stock market.

The once-in-a-decade play

The niche that this opens up is that some investors are simply selling all stocks in the FTSE 100. The truth is that not all companies are that negatively impacted by these higher rates. This could be due to low debt levels or selling essential goods/services. Yet the share prices have still taken a bit of a hit recently, with Thursday being another example. At the moment, only nine shares in the FTSE 100 are up on the day!

I think this opens up a great play for income stocks. For companies that aren’t overly impacted, financials should stay strong and dividend payments should continue. Due to the share price falls, it pushes dividend yields higher.

Therefore, I believe investors can take advantage and lock in the generous dividend yields currently on offer. In theory, when the market turns to being more optimistic, or if we get rate cuts next year, the shares should rally.

This should provide capital gains from the share price. However, the dividend yield would fall in this case. Yet because of buying when the stock was low, the investor will have locked in the historically higher yield (assuming the dividend per share payment hasn’t changed).

Points to note

The main risk to this view is if we see continued hikes from the Bank of England beyond what we currently expect. It could be that the stock market falls further in coming months, providing an even better time to buy. If investors purchase now, it could mean holding an unrealised loss in the short term.

Ultimately, perfectly timing the market is impossible. Yet from where we currently stand, I believe this is a rare chance to invest in high-quality dividend shares.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing For Beginners

Investing Articles

Can the FTSE 100 index hit 10,000 in 2025?

The FTSE 100 hit an all-time high of 8,475 in the first half of 2024. Could the British stock market…

Read more »

Investing Articles

How much would I need in an ISA to earn a £500 monthly passive income?

This writer explores the passive income potential of an ISA and highlights a unique FTSE 100 trust that he thinks…

Read more »

Investing Articles

Forget gym goals, here’s how to build wealth without maxing out ISA contributions in 2025

Our Foolish writer explains how Investors can start building wealth in 2025 by opening an ISA and investing in undervalued…

Read more »

Young black man looking at phone while on the London Overground
Investing Articles

No savings at 30? Use Warren Buffett’s golden rule to build wealth through investing

When it comes to investing, Warren Buffett’s advice reigns supreme. Dr James Fox explains how investors can build wealth with…

Read more »

Investing Articles

FTSE shares in 2025: an opportunity to get rich?

The FTSE hasn’t universally satisfied investors in recent years, but there are certainly enticing opportunities on the index in 2025.

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

2025: a great opportunity for investors to get rich and work towards a second income?

To earn a second income from investing, we typically need a good pot of money. Dr James Fox explores where…

Read more »

Investing For Beginners

2 UK stocks that could be impacted if the US introduces trade tariffs

Jon Smith looks at the UK stocks that could come under pressure this year if the US starts to adopt…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

If a 30-year-old puts £500 a month into a Stocks & Shares ISA, here’s what they could have by retirement

UK residents can leverage the incredible benefits of the Stocks and Shares ISA to create a retirement fund separate from…

Read more »