Rising interest rates, the impact of inflation, and why a weakened pound makes for exciting investment opportunities.

Over the last couple of weeks, we have been active with fund manager meetings – meeting with nine of the leading fund managers in the UK. From these meetings, we got an update on their views on the stock markets – both in the UK and overseas – inflation and rising interest rates.

The consensus from these meetings is as follows: while recent events have meant that the pound sterling has been volatile, there are potential benefits for investment. Read on to find out more.

Inflation and interest rates

The energy price cap that the UK government introduced is going to reduce the current rate of inflation – at the moment just below 10% – by somewhere between 3% and 5% over the next few months. In addition to this, the fund managers we met believe that inflation will be affected by rising interest rates by the Bank of England.

In general, they expect that inflation should be back to a more normal level and far more under control by mid to late 2023.

The Bank of England’s intervention of increasing interest rates comes rather late in the day – they certainly should have started increasing interest rates much earlier than they did. They had originally believed that the inflation would be transitory, but it proved to be much higher and longer term than expected. Their increase in interest rates now will start to have an effect on inflation as well as the economy.

Effects of rising interest rates

While rising interest rates are bad for anybody borrowing money and those who are not on a current fixed rate – or those whose fixed rate is ending – they should slow the rate of inflation down. That said, the Bank of England will need to be quite aggressive with the increases in order to bring inflation down to the level where it needs to be

This will obviously slow the economy down. In addition, people will be spending more money on debt, such as mortgages, credit cards and so on. Banks will benefit, making considerably more profit than they were previously – deposit rates haven’t been increased anywhere near as much as the borrowing rates.

Equities

Regarding equities, it has been a very volatile time over the last nine months – particularly for the mid-250 cap index of shares, smaller companies and AIM stocks. This is going to continue since there has been a breaking away of the fundamental values.

All the UK equity fund managers are telling me that there are fantastic companies out there – they are cheap, have good balance sheets and good order books, and they are increasing their dividends. While there will be an economic slowdown next year, these companies are all still very positive.

However, the price of their shares is not reflecting the value of the company. This is because the sentiment towards the UK economy and stock market around the world is not favourable right now. The shares are unloved, particularly by overseas investors, which leaves them in a position where they are not reflecting their actual long-term value.

This means that there are considerable opportunities to be had for investors who are willing to look past the potentially unjustified sentiment shared by many over the UK stock market.

Strength of the pound sterling

The pound against the dollar is at historically low rates, having dropped over 20% this year alone. As of the 27th of September, its value was $1.08 to every pound. This is a dramatic fall – it was around $1.20 to the pound at the start of August and $1.37 to the pound at the start of the year.

This drop in value of sterling is due to this lack of confidence in the UK economy and stock market (and in some respects, the current government), in addition to the US Federal Reserve having taken action to raise interest rates quicker and higher than the Bank of England, their UK counterpart. 

This means that if you have money overseas that you want to leave on deposit, you will get much better interest rates in America than the UK. In addition, the strength of the dollar is supported by being a hedge against uncertainty – it is the currency that other countries flock to in times of volatility and uncertainty. 

This low rate of exchange has the effect of making imports priced in dollars more expensive and exports priced in pounds cheaper. This is good for exporters, but bad for importers. Unfortunately, the UK imports considerably more than we export, which is another reason why some may see UK stocks as less worthy of investment.

Britain’s import-heavy market will add to inflation concerns, particularly with the energy markets – most of the oil and gas that we import is priced in dollars. This means that, sadly, inflation rates and higher costs in the energy markets will not turn around any time soon.

Final thoughts

Overall, the Applewood Independent consensus, influenced by the best fund managers in the country, is that there is a great opportunity for equity in UK investment. While it will be volatile in the short term, it’s one of the cheapest major markets out there at the moment. Looking ahead on a three-year basis, there is a considerable amount of upside (between 50 and 100%) on some of the share values that the fund managers are currently investing into.

Because share prices are lower than the actual value of the company and the market is cheap, investments made now have the potential to be extremely rewarding. It could be possible to get a return equal to the price paid for a share in just five years, from dividends alone in some cases. As investors realise this, particularly those with dollars to spend, investment should start to return to the UK markets, which will in turn increase the value of our stocks here in the UK.

We know that this current market volatility is stressful for everyone – if you’re an investor, it’s wise to seek independent financial advice. At Applewood Independent we know that the UK markets will recover as investors recognise their value.

If you’d welcome our input, expertise and experience, please get in touch by emailing me at david@applewoodindependent.co.uk.

The views expressed in this article are those of the author and do not constitute financial advice. Applewood Independent Ltd is authorised and regulated by the Financial Conduct Authority. For financial advice designed for you and your specific circumstances, please contact the author using the contact details provided in this article or, alternatively, contact the Applewood Independent Ltd office on 01270 626555.

The value of your investment can go down as well as up, and you may not get back the full amount invested.

Past performance is not a guide to future performance.