EC The Threat And Risk Of Rising Interest Rates: Separating Fact From Fiction

  

Summary and Conclusions

To summarize, interest rates can be an important factor that must be considered when making valuation decisions about the stocks in your portfolios.  However, the level of interest rates and where they might go in the future are not the only factors that should be considered. Stock analysis and investing are much more complex than simply focusing on a single metric. Therefore, I believe that investors are best served by considering all the factors that comprise the valuation levels of their portfolios.

With that said, I believe rising interest rates, if and when they do occur, could be a critically important factor to consider, especially if the stocks in your portfolio are trading at excessive valuations. On the other hand, if your portfolio is comprised of attractively-valued stocks, I would not let the fear of a rising interest rate environment deter you. In order to add additional perspective, I offer two of my favorite Warren Buffett quotes. This first one addresses interest rates specifically, as well as other factors that Warren tends to ignore.

“If we find a company we like, the level of the market will not really impact our decisions. We will decide company by company. We spend essentially no time thinking about macroeconomic factors. In other words, if somebody handed us a prediction by the most revered intellectual on the subject, with figures for unemployment or interest rates, or whatever it might be for the next two years, we would not pay any attention to it. We simply try to focus on businesses that we think we understand and where we like the price and management.” Warren Buffett

This next quote was written in 1994. However, I believe the underlying principles remain relevant today, and I believe this quote speaks volumes about what I was attempting to convey with this article.

“We will continue to ignore political and economic forecasts which are an expensive distraction for many investors and businessmen. Thirty years ago, no one could have foreseen the huge expansion of the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the dissolution of the Soviet Union, a one day drop in the Dow of 508 points, or treasury bill yields fluctuating between 2.8% and 17.4%. But surprise – none of these blockbuster events made even the slightest dent in Ben Graham’s investment principles. Nor did they render unsound the negotiated purchases of fine businesses at sensible prices. Imagine the cost to us, if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.” Warren Buffett, Berkshire Hathaway 1994 Annual Report

In closing, I believe that investors are wise to consider all factors before making important investment decisions. Considering the high valuations of many blue-chip dividend paying stocks today, the impact of potentially rising interest rates should not go unnoticed. However, I believe it is a mistake to believe that any one factor, whether it be interest rates or political environments or any other, should be allowed to dominate your thinking. I believe in building portfolios one stock at a time. But most importantly, I believe that evaluating the specific merits of each individual holding is significantly more important than worrying about generalities. Ceteris Paribus.

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Disclosure:  Long PG, MCD, MCK, JNJ

Disclaimer: The opinions in this document are for informational and educational purposes only and should ...

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Comments

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Elliott Morss 3 years ago Contributor's comment

Chuck:

Thanks for your interesting piece. Just a couple of points I would mention:

1. Many have noted that P/E ratios are getting high relative to historic P/E. I would mention that the US has been the place for the world to invest. And this upward shift in demand will increase the "P" in the P/E ratio. So perhaps we should expect a higher P/E ratio going forward for US stock markets.

2. I am wondering how effective the Fed can really be in raising US interest rates. There is a healthy demand now for US Federal debt, and higher debt will certainly increase the demand for US debt.