Will Inflation and Rising Interest Rates Threaten Your Stocks?

Famous investor Peter Lynch once quipped that “there is always something to worry about” in investing.

And if you’ve been following the news headlines over the past year, this statement certainly feels true.

From the pandemic and the Russia-Ukraine war to inflation and rising interest rates, it can feel like an endless flow of negative news.

But the real question for investors should be – are these concerns going to impact my investments and lower my overall returns?

In particular, Singapore is experiencing its worst core inflation in a decade.

Core inflation has hit 3.3% in April, driven higher by electricity and gas tariff hikes.

In the US, inflation has hit its highest level in 41 years of 8.6%.

Because of the surge in the prices of goods and services, the US central bank plans to raise interest rates aggressively in the coming months.

Just how badly will inflation and interest rates impact your wealth? Let’s analyze each attribute to see its effects.

surging inflation

Inflation raises overall prices, making goods and services more expensive.

In turn, this phenomenon lowers consumer demand as people tighten their wallets due to pricier goods.

Many companies will experience some form of lower demand as higher prices tend to crimp consumer sentiment.

The effect tends to be short-lived if wages can rise in tandem with inflation.

However, another problem now arises – that of higher staff costs that eat into operating and net profits.

That’s why you should be looking at two kinds of businesses that are relatively insulated from inflation.

The first is essential goods and services such as necessities and healthcare services.

Even when prices rise, people will find it tough to cut back, thus allowing these types of companies to enjoy resilient revenue and profits.

Sheng Siong Group Ltd (SGX: OV8) should remain relatively insulated from rising prices as its business involves the sale of fresh foods and necessities.

Raffles Medical Group (SGX:BSL) and Parkway Life REIT (SGX: C2PU) are in the healthcare sector and should enjoy steady demand for their services.

The second type of business can raise the prices of its products in line with inflation due to strong brand equity.

Although higher raw materials and packaging prices could cause margins to fall in the near term, the company can raise prices to counteract this effect without suffering an adverse fall in sales volume.

Some examples of companies that have strong brands with pricing power include Nike (NYSE: NKE), Kimberly Clark (NYSE: KMB) and Procter and Gamble (NYSE:PG).

Rising borrowing costs

The sharp increase in interest rates has many an investor worried as borrowing costs are set to increase.

REITs are the first in line to be impacted as they rely heavily on debt financing to fund their operations and acquisitions.

The good news is that many REITs have low borrowing costs to begin with and also hedge their debt to fixed rates using financial instruments such as swaps.

take Keppel DC REIT (SGX: AJBU).

The data center REIT has a low cost of debt of just 1.8% as of 31 March 2022.

Three-quarters of its total debt is on fixed rates, such that a one percentage point increase in interest rates will only impact distribution per unit (DPU) by 1%.

For Mapletree Logistics Trust (SGX: M44U), the cost of debt was also low at 2.2%.

79% of its total debt is hedged, such that a 0.25 percentage point increase in rates will decrease its DPU by just S$0.0001.

Another way to stay insulated from increasing rates is to own companies that have little or no debt.

VICOM Limited (SGX: WJP) comes to mind, and the vehicle inspection business had S$75.4 million in cash with no debt as of 31 December 2021.

Get Smart: Stick with quality

During times of turbulence, it’s best that you stick with quality stocks.

Quality could include blue-chip companies such as Singapore Exchange Limited (SGX:S68) gold OCBC Bank (SGX: O39).

It also includes REITs with strong sponsors such as Capital Land Integrated Commercial Trust (SGX: C38U) that know how to manage both inflation and higher interest rates.

Parking your money in such companies should give you both peace of mind and a satisfactory total return.

The negative headlines may be disturbing in the interim, but you should do just fine over the long term.

Not sure which REIT to put your money in? Use our 7-step REIT checklist to find one that fits into your retirement plan. Checklist is inside our latest FREE report “Singapore REITs Retirement Plan”. Click here to download it now.

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Disclaimer: Royston Yang owns shares of VICOM, Keppel DC REIT, Singapore Exchange Limited, Nike and Raffles Medical Group.

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