With interest rates set to rise, is a stock market crash coming?
It looks as if the Bank of England will move to increase interest rates in the next few months. Nothing is guaranteed. But based on recent rhetoric, analysts reckon the central bank could hike rates before the end of the year, or in the first half of 2022. Unfortunately, there is a chance this could spark a stock market crash.
Plenty of risks
Over the past decade, equity markets worldwide have chugged higher thanks, in part, to low interest rates. These make it more appealing to borrow money to invest and can push up company valuations.
With consumers earning almost nothing on their money in savings accounts, many have also turned to equities searching for a better return. If interest rates rise, these investors may not stick around.
Higher interest rates could also cause stress in the economy. Indebted companies may struggle to meet higher interest charges. This could lead to an economic slump, which would be bad news for stocks.
Put simply, there is a range of different risks that could cause a stock market crash after an interest rate hike. The bad news is, it is impossible for me to say at this stage if a rate hike will cause a crash. Trying to predict the future direction of stock markets is a fool’s errand. And it can be downright dangerous if money is at risk.
Therefore, the approach I am using to protect myself against the potential market crash is diversification.
Stock market crash protection
I have acquired stocks for my portfolio that should continue to prosper, no matter what the future holds for the macroeconomy. These include corporations like Diageo, which have stronger balance sheets and will be able to pass higher costs on to consumers. Although, due to the company’s association with alcohol, it may not be suitable for all investors.
Companies like Rio Tinto may also provide protection against higher rates. This firm has a strong balance sheet, and commodity prices should match inflation in the long run. That said, commodity prices can be incredibly volatile. So, there is no guarantee the group will be able to escape any economic turbulence. Still, I would buy the stock to diversify my portfolio.
As well as acquiring these companies, I would also avoid businesses that may struggle in a higher rate environment. A great example is SSP Group.
This foodservice group entered the pandemic with a weak balance sheet and suffered as most of its outlets in airports and railway stations were forced to close. It could continue to struggle if rates move higher. That said, if the economic recovery continues to gain traction, the stock’s recovery could accelerate as well.
By using the above investment strategy, I think I will be able to avoid the worst effects of a stock market crash if one does occur. If not, I think the high-quality businesses outlined above will continue to perform.
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Rupert Hargreaves owns shares of Diageo. The Motley Fool UK has recommended Diageo and SSP Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.