Over the past 12 months, the FTSE 100 is up 8.6%. However it’s not reflective of the index’s underperformance over the last decade.
As many readers will recall, a year ago we were in the middle of Liz Truss’s ill-fated premiership that sent the blue-chip index into a tailspin.
The underperformance of the index, however, is clear when we look over five years. Over that half-decade, it’s only up 1.1%.
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Depressed environment
Rising interest rates have had a noticeably negative effect on the performance of the FTSE 100, contributing to negative sentiment in the post-Covid/Brexit environment.
Higher interest rates translate into increased borrowing costs for businesses, which can put pressure on their profitability.
However, more significantly, they also tend to prompt a shift in the flow of capital.
Investors often find higher-yielding cash and debt investments more attractive in such conditions, diverting their funds away from shares.
This movement of money can contribute to downward pressure on stock prices.
Moderating interest rates
Interest rates are expected to fall to around 2%-3% in the UK over the next few years, according to some economists — we’ve already seen the Bank of England’s Monetary Policy Committee halt its monetary tightening cycle.
This is because high interest rates can slow down economic growth, and the Bank of England will want to avoid a recession.
We should also consider political pressure. The government will want to see the economy return to growth and lower its repayments on debt.
The main reason
Falling interest rates tend to drive investors towards shares while discouraging them from holding cash and debt. This is the simple reason why I expect the FTSE 100 to rise, even if we enter a mild recession in the UK.
This shift occurs for several reasons. When interest rates decrease, the returns on cash and fixed-income investments, like bonds and savings accounts, diminish.
Consequently, investors seeking higher returns may turn to shares, which historically offer the potential for greater capital appreciation and dividend income.
And as interest rates decline, the cost of borrowing for businesses and individuals becomes cheaper. This can stimulate economic growth and boost corporate profits, which often positively affect share markets.
Investors may perceive shares as more attractive in such an environment, expecting increased earnings and potentially higher stock prices.
Furthermore, falling interest rates can reduce the money generated from fixed-income investments, making shares comparatively more appealing. In pursuit of a better yield, investors may allocate more of their capital to dividend-paying stocks.
Overall, the interplay between interest rates and investment decisions underscores the dynamic nature of financial markets, where shifts in rates can significantly influence asset allocation strategies.
With the above forecast in mind, I’ve been moving my portfolio towards stocks and shares ahead of the interest rate cuts I expect to see over the medium term. It’s a slow process, but by staying one step ahead of the curve, I hope to beat the market.
