News
Where do we stand in a higher interest rate environment?
By Michael O’Connor
You may have noticed that financial media have an unhealthy obsession with interest rates, but our fear of higher rates is justifiable for the most part.
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Higher interest rates impact markets in several ways.
From a financial perspective, the future cash flows of a company are discounted by interest rates; therefore, higher interest rates mean a lower present value of future cash flows.
It’s simply ‘A bird in the hand is worth two in the bush’ situation. Higher interest rates mean the money companies are forecasting they will make in the future is now worth less in today’s terms once higher interest rates/inflation have been considered.
From a relative value perspective, the equity risk premium is reduced. The equity risk premium is the extra returns over the risk-free rate that investors expect to receive given the higher risks they are taking by investing in the stock market versus the risk-free rate.
If we consider US Government Treasury bills as the risk-free rate, then as the interest rates being offered on these T-Bills increase, the hurdle rate equities need to beat to justify the additional risk being taken also increases.
The interest rate on one-year Treasuries just a year ago was 0.07%, so stocks were the obvious choice versus an asset that offered zero returns. But the 1-Year Treasury Rate has jumped 60x in under a year to over 4%.
In investing, everything is a relative choice, so as interest rates increase in risk-free assets, equities become less compelling versus their risk-free counterpart.
The questions become, why take on the extra risk of the stock market when I can get a guaranteed 4% from a risk-free asset?
This reduction in the equity risk premium can lead to an outflow from equities into more risk-averse fixed-income products. This reduction in demand for stocks can result in lower valuations over time.
From an economic perspective, higher interest rates will increase the cost of credit.
Higher interest rates make loans more expensive for both businesses and consumers. As a result, everyone ends up forgoing upcoming projects or spending more on interest payments.
This reduces the demand side of the economy by reducing the supply of money in circulation, leading to lower inflation (in theory) and weaker economic activity.
This slowdown in consumer spending will reduce business activity and negatively affect company earnings.
And as company earnings fall, so too do the prices people are willing to pay to invest in these companies.
So where do we stand now that we are in a higher interest rate environment?
Market Outlook
Inflation remains persistent, and as such, interest rates look set to increase further, creating less than favourable economic conditions.
But whether the economic outlook is good or bad is never the question we are trying to answer as investors.
The only question that matters is how much of this negative news is already priced into the market.
With the S&P 500 currently down 23% YTD, it appears that a mild recession has already been priced in.
The possibility of a deep recession is still very much on the table as inflation persists. Still, as data continues to soften, we see encouraging signs that inflation may have peaked.
You’ll never time the markets perfectly, and short-term risks remain, but the long-term expected returns of the stock market have improved dramatically in recent months.
I, for one, am long-term bullish on the stock market. These current prices make it an attractive time to build out my long-term positions.
Interview conducted by Aodhagán Ó Súilleabháin, Cormac Flanagan, and Ryan Twomey.
Name: Kieran O’Leary – Entrepreneur and Killarney businessman.
Year of Graduation: 2005
Occupation: I would be the Jack of all trades and the master of none. I am involved in the hospitality industry. I have Corkery’s Bar, Revive Café, Ruckus Café and I’m a part of Integrity gym, so I do a lot of coaching. The passion by me would be probably in the fitness industry, because I played at a high enough sporting level and that’s come to an end now so I’m kind of concentrating on the coaching early mornings, hospitality day and evening and I have a young family as well so that’s obviously the biggest priority of all.
Could you describe a typical day for you?
I wake up at 5.30 and I am in the Gym for 6am. I work with clients till 8.30 – 9:00am. I then have school drop off, check the stock in the cafes and open Corkery’s. I kind of float around all day, kind of just helping where I can, and then evening time is probably the most hectic, at home, the kids might have football, well the young fella has football, he does a bit of Jiu-Jitsu, and dinner, stop, start, repeat the following day. I work hard, when you’re self-employed it can be difficult, but I try to get down time on Sundays or maybe Wednesdays.
What drew you to St Brendan’s as a school?
It was the sports that kind of drew me. The past pupils that I would have known from the sports clubs and would have seen their careers progress. It’s renowned, the history behind the Sem is unbelievable. I wasn’t really going anywhere else. The history behind it, the stories that come out of it, the people that have progressed and done so well in life. I don’t mean success by wealth, they seem to be happy in their professional life, happy with their life decisions and I suppose the Sem has a huge part playing in that.
Would you have kept in contact with any teachers?
Even now you see older teachers that may be retired or are even still there, they still have a bit of time for you, and they’ll stand in the street and say how are you getting on? We live in a small town, where everyone knows kind of everyone’s business to such an extent, so I think just the camaraderie, friendships and like the great times we had, I’ll always remember that.
Would you have kept in contact with your classmates?
The friends I made. They are lifelong friends. We were lucky enough to be a part of a good few sporting teams, and we would have progressed through the Kerry GAA side of things, and then there’s a lot of them working around here, a few of them abroad, but you’d have your core five or six fellas that you still stay in contact with. Outside of that if you saw past students of the school around the town, of course you’d stop and talk to them.
Were there any specific academic programmes or teaching methods at the school that helped you succeed in what you’re in today?
I didn’t apply myself the way I’d like to which is kind of a regret, but I did Business Studies with Joanna Ryan, she was a very good teacher. I went on to do business which I didn’t complete in IT Tralee, and funnily enough, then I got involved in the business side of things, so it’s funny how things work out. Just because you mightn’t do the best Leaving Cert doesn’t mean that you’re a failure, there’s always an opportunity around the corner and if you’re willing to apply yourself in any shape, way or form then you’ll succeed. It’s all about the mindset, discipline and as I said, my mindset was GAA, maybe even soccer related when I was that age, I could see nothing else, I was a bit blinkered, but as you broaden your horizons as you get a bit older, more mature you realise there’s different ways to go about your goals.
Can you share an example of how a teacher or staff member made a meaningful impact on your growth.
I’d say Seamus Grealy to be honest, because he is an excellent teacher. He was a soccer coach and he would have seen the potential in me and even though the application mightn’t have been there at times. He still persisted and gave me that chance to try and achieve the best possible grade I could within the Leaving Cert year. I would have done honours English even though my mother and father were saying “What are you doing?, you know, because I hadn’t the work done or whatever. The fact that he gave me that kind of TLC. I needed, that kind of arm around the shoulder, to say, listen there’s more in you, try your best, and as you know he can be firm as well, I just found him pretty good to deal with.
St Brendan’s College: Voices from the Halls
Interview conducted by Aodhagán Ó Súilleabháin, Cormac Flanagan, and Ryan Twomey. Name: Kieran O’Leary – Entrepreneur and Killarney businessman.Year of...
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