Interest rates are forecasted to reach around 3% by the end of the year, as policymakers seek to dampen a rate of inflation that recently hit a 40-year high.
Of course, how quickly interest rates rise and to what level could have a significant impact on equity market valuations. As a result, some investors may seek to forecast or model different monetary policy scenarios when deciding how to apportion capital at the present time.
However, due to the presence of a wide range of other factors that can impact share prices, such as geopolitical risks, it is impossible to accurately judge how the stock market will perform in the future. Even the most complex formulas and computer models will be unable to provide investors with a prediction that proves to be completely accurate over the coming months and years.
A simple approach
Therefore, a far simpler approach that focuses on company fundamentals could be a worthwhile strategy. It may help an investor to identify the strongest companies that can more easily cope with a slowing economy, as well as those companies that are able to deliver improving financial performances as the macroeconomic outlook likely improves in the long run.
Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) Vice Chairman Charlie Munger (Trades, Portfolio) is known to prefer a simple approach to portfolio management. He once said, “One of the greatest ways to avoid trouble is to keep it simple.”
Value investing
In my view, a simple approach to investing entails purchasing companies for less than they are worth and holding them for the long run. Clearly, valuing companies is never an exact science due to the uncertainty that all industries constantly face. However, by looking at a company’s performance over recent years and the value of its assets and cash flow, it is possible to estimate its intrinsic value.
Purchasing a stock at a discount to this level is a simple means of protecting against a market downturn, should rising interest rates dampen economic growth. In addition, a margin of safety provides greater scope for capital growth as the economy and stock market likely recover over the long run.
Portfolio management
While holding a minor part of a portfolio as cash is likely to reduce returns in the long run, it could be prudent at the present time. After all, rising interest rates have historically had a negative impact on the stock market as other assets become relatively more attractive and a slowing economic outlook reflects poorly on company earnings.
Cash clearly offers a negative return on an after-inflation basis at the moment. But it could provide a simple means to invest in stocks at even lower prices should their valuations deteriorate further in the coming months amid a period of rising interest rates.
