How will the normalisation of monetary policy effect stock prices? I have been wary of tackling this question head-on because it involves too much crystal-ball gazing for my taste. Crystal-ball gazing is a long-standing pillar of financial punditry, but I am not convinced it is a useful starting point for investment. At Investors Chronicle we prefer to identify cheap assets than guess what will happen in the future - an exercise doomed to at best spotty success.
However, the impact of rising interest rates is a sufficiently crucial question to warrant attention. I will take a stab at answering it using the only credible tool at any observer’s disposal: history.
First, very recent history. This year, the sectors perceived to be most at risk from rising interest rates - general retailers, travel and leisure and house builders - have sold off. The obvious logic is that consumers, who in Britain can fix their mortgages for at most five years, will soon have to pay more for their home loans, leaving less money for clothes, gadgets and restaurants.
This is despite the fact most retailers and restaurant or pub chains have reported decent results, buoyed by the rise of sterling - which cheapens some of their costs - and a recovery in high-street spending. After years of torpour, retail sales volumes showed decent growth in the first half, ranging from a low of 3.6 per cent in rainy February to 7.1 per cent in April, according to the Office for National Statistics.
Will the underperformance of these sectors continue? This is where a longer view comes in useful. In the graph below, I have plotted the performance of the general retailers in the FTSE 350 (to which I restrict my analysis for simplicity’s sake) relative to the wider market against the Bank of England base rate, using data running back to 1985.
The most striking thing about this graph is the extent to which retailers have underperformed. Supposedly Margaret Thatcher’s premiership in the 1980s ushered in a period of consumerism. If so, it filled consumers’ houses rather than investors’ pockets. And this was against a long-term backdrop of falling interest rates. So if you believe in Kondratieff cycles or other theories that suggest we are in for a sustained period of rising rates, that doesn’t seem to be a reason – in itself – to avoid retailers.
Looking at shorter time horizons, however, the opposite is true. When rates were rising in the mid noughties, retailers underperformed. The same is true of the periods in the mid 1990s and late 1980s when, against the much longer-term backdrop of declining bond yields, the Bank was increasing its benchmark rate. In fact, there seems to be no period of rising rates in the past three decades that was not accompanied by retailer underperformance. This is clearly ominous.
So much for history. I started by writing that investors should look for cheap stocks rather try to forecast events. So what do valuations tell us? According to Bloomberg, retailers are now trading on about 14.5 times consensus earnings for the next 12 months. That’s down from over 16 times at the peak in March, but well above the 10-year average of 11 times. In other words, retailers may have corrected 10 per cent, but they remain dear.
Meanwhile, retail sales are slowing. Volumes (excluding petrol) were up 3.4 per cent year-on-year in July – still robust, but the weakest figure since November. As comparatives strengthen and consumers start to factor in the need to remortgage at a higher rate, retailers may start posting underwhelming like-for-like growth figures. There may be interesting individual stories, but the sector as a whole is probably best avoided for now.
