Interest rates and asset prices

Interest rates impact asset prices. This is an immutable law of finance. The recent pronouncements by the US Federal Reserve on interest rates is in stark contrast to the policy they have had on interest rates since December 2018 and have caused the recent market volatility and declining asset prices.


In the depths of the pandemic in August of 2020, the US Federal Reserve announced a new framework to target “average inflation” of 2% without disclosing how they would calculate the average. The Federal Reserve also stated that they did not foresee interest rate increases until 2023.

As the fight against COVID progressed, signs of inflation emerged driven by increased consumer spending resulting from unprecedented stimulus and savings on travel and entertainment. Supply chains were disrupted by the resulting high demand for goods. The Fed characterised inflation as “transitory” during this period. In the last quarter of 2021, the Federal Reserve ‘retired’ the word transitory from their discussions regarding inflation.

Inflation hit 7% in the United States in December 2021. 7% is excessive relative to the desired target of 2% and is the highest level of inflation in almost 40 years.

Interest Rates

The US Federal Reserve’s recent posture prioritised full employment and economic recovery ahead of stable prices (inflation). Our last blog highlighted the Federal Reserve’s intent to reduce Asset Purchases, but the Federal Reserve did not specify any interest rate increases when we wrote our previous blog.

The Federal Reserve has changed its view on interest rates and signalled its intention to increase interest rates at their next meeting in March 2022, coinciding with the termination of Asset Purchases.

There is no guarantee that the Fed will adhere to a regular pace of tapering or rate increases. It is not possible to predict their actions. Rates could rise faster or slower, depending on the US Federal Reserve’s view on inflation and employment.

“As we work our way through this, meeting by meeting, we are aware that this a very different expansion…Those differences are likely to be reflected in the policy that we implement,” said Powell, who used the word “nimble” at least three times.
Source – Reuters

The Fed has entered a period where they may want to slow the economy and hopefully cool inflation by raising interest rates. There is no exact science to determine to what level interest rates should rise in order to get the effect they are seeking. Raising rates may slow the economic recovery too much, impact employment and asset prices too much.

Asset Prices

The prospect of rising interest rates has reduced assets prices. While all asset prices have declined, speculative growth companies have dropped more. The table below lists growth companies that were popular “pandemic” and “meme” stocks. These businesses do not generate cash and are valued based on enormous growth assumptions and predictions. Because low-interest rates stimulate the economy and make it easier for companies to grow, speculators could justify high expectations and resulting high valuations; in their minds anyway.

The average decline for the group is 66% from their 52 week highs.

We do not predict the future performance of these companies, but we do highlight that many shareholders are currently in a world of pain. Shareholders must decide if these businesses will continue long enough to grow into their former valuations.

Cash generative businesses subject to lower expectations have fared better. This selection of companies, which meet AXIAM’s brand, cash, and debt criteria, have declined less in the face of the market decline, and are 57% ahead of the highfliers.

In addition, several companies will benefit from re-opening the global economy. These are leaner businesses than the 2019 pre-pandemic businesses and have less competition and more pricing power.


Many unknowns, like a new COVID strain, geo-political upheaval or other impossible to predict events could rapidly change the economic outlook.

It is not possible to predict the future of interest rates in the face of so much uncertainty. Not even the Federal Reserve knows what future rates will be, as demonstrated by their policy revisions of the last 18 months.

As emphasised in the previous blog, the companies we own are well-positioned to prosper in a rising rate environment, should that materialise. They don’t have to borrow money to run their businesses. We will, however, where appropriate, shift funds from companies that have grown beyond a sensible valuation to companies that are undervalued and stand to benefit from a re-opening economy. Importantly, we will not sell out of a company we own unless consumers no longer desire the brand or where a company has made a significant change in its strategy which has impacted its ability to generate cash. Short-term valuation changes are not a criterion for disinvestment.

Volatility and falling prices are the scourge of speculators but the friend of long-term investors. We intend to take advantage of both scenario’s, should they materialise.

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