Rising inflation and interest rate impact your portfolio – Here’s why and what to do now

Conundrum of high inflation and rising interest rates may impact earnings of businesses in each sector differently.

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Historical evidence suggests that equities have done well after the initial phase of volatility recedes in a rising interest rates environment.

The stock market bull run witnessed since the outbreak of Covid-19 till about January 2022 was largely on the back of easy monetary policy globally. Once the US FED sounded the alarm bell for rate hikes and followed it up with a half-percent hike in May 2022, and signalling more in the months ahead, the stock valuations were bound to come down. Most highly valued stocks fell like nine-pins across industries.

The US inflation may further spoil the sentiments of investors worldwide. The conundrum of rising commodity prices, rising inflation, and thereby tight monetary policy may keep volatility intact in equities for some time.

Edelweiss Mutual Fund in a recent note explains how inflation impacts equities and which sectors are expected are impacted more.

How inflation impacts the economy: Higher inflation brings with it rising interest rates which in-turn impacts multiple sectors and its growth prospect. With higher commodity prices, businesses grapple with high input costs, resulting in passing on higher prices to consumers. Higher prices in-turn impacts demand.

Rate hike and markets: Historical evidence suggests that equities have done well after the initial phase of volatility recedes in a rising interest rates environment. In fact, equities have delivered one of the best returns during the 2004 to 2008 period when interest rates and inflation kept rising.

Rate hike and Sectors: This conundrum of high inflation and rising interest rates may impact earnings of businesses in each sector differently. The data below shows how different sectors have performed during high inflation and low inflation conditions in the last 10 years. As seen, Auto, Pharma and Banks have performed well during high inflation regimes while businesses that have their demand and input costs sensitive to inflation and rising rates have done poorly – States the Edelweiss Mutual Fund note.

What to do

The same set of stocks and your mutual fund schemes may not recover to the price levels seen in the past. Inflationary pressures on the operations of businesses could remain a key factor unless other factors change. As a mutual fund investor, it’s time to review your portfolio after speaking to your financial advisor. Have a close look at the allocation across industries in your diversified funds and even your thematic funds, to take a call whether to stick to them or shift to other funds. While the market is resorting to sector rotation, it may be the time to do the same with your portfolio.

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