Although the S&P/ASX 200 Index (ASX: XJO) is still up a decent, if not spectacular, 2.1% in 2023 so far, I’m becoming more and more worried about where the share market is currently sitting.
Don’t get me wrong, I’m still a great believer in the long-term power of the ASX to drive wealth creation. After all, the ASX 200 has never once in its history failed to exceed a previous all-time high. I’m still investing in ASX shares, and I plan to continue to do so indefinitely. But there is something that has been niggling at the back of my mind lately.
It’s interest rates.
Of course, many Australians are worried about interest rates at the moment. If you own a home, you wouldn’t have been able to escape the avalanche of interest rate rises that the Reserve Bank of Australia (RBA) has unleashed upon the economy over the past 13 months. Unless you were fortunate enough to fix your mortgage back in 2020 or 2021.
But even then, the clock will be ticking on your fixed-rate period.
But that’s not why I’m worried about the share market.
Interest rates are supposed to be directly correlated to the performance of shares. If rates rise, the return that you can get on ‘safe assets like term deposits and government bonds rises. This makes them more appealing than ‘riskier’ assets like shares and property. Or at least that’s how the theory goes.
The legendary investor Warren Buffett concurs. A couple of years ago, he described interest rates as ‘financial gravity’. The higher they are turned up, the more they pull asset valuations down to earth.
Teachings from Warren Buffett
To expand, Buffett said the following, way back in 1994:
The value of every business, the value of a farm, the value of an apartment, the value of any economic asset is 100% sensitive to interest rates… the higher interest rates are, the less that present value is going to be.
Every business, whether it’s Coca-Cola or Gillette or Wells Fargo — its intrinsic valuation is 100% sensitive to interest rates.
Now, consider this. At the start of 2021, interest rates in Australia were sitting at a record low of 0.1%. Today, after 12 hikes from 13 meetings of the RBA, the cash rate is at a 12-year high of 4.1%.
By Buffett’s logic, we should have seen at least something of a pullback in the ASX share market, given that massive surge in ‘financial gravity’.
Instead, as you can see below, the ASX 200 is today sitting pretty much where it was back in May 2022, when the first of those 12 rate hikes was executed:
Why hasn’t the ASX 200 been dented by interest rates?
Well, perhaps the rules have changed. Perhaps interest rates no longer pull down assets like they once did. Perhaps there is still so much stimulus money left over from the pandemic washing around the economy and the financial markets that these hikes have had no effect.
Or perhaps investors have been postponing the inevitable, and the ASX 200 is due for a major correction.
I don’t have a crystal ball, and I certainly am not qualified to explain why the share market hasn’t adjusted even slightly to these interest rate rises. But it has me worried that we might be in for some choppy water ahead. Those worries only rise every time the RBA imposes yet another rate hike on the economy (get ready for 4 July, people).
I’ll still keep on investing, of course. The share market has dealt with high rates before and can do so again. But that will be cold comfort for many investors and superannuation pensioners if the share market meets the RBA even halfway.
