How Interest Rates Affect Investments

The Great Financial Crisis and How Subsequent Loose Monetary Policy Shaped Financial Markets 

It has been 15 years since the collapse of Lehman Brothers, triggering the Global Financial Crisis (GFC) and an era of loose monetary policy. In September 2008, the Bank of England (BoE) base rate was 5.0%. Six months and six rate cuts later, it had fallen to 0.5% where it would stay for the majority of the next 15 years, until returning back to the 5.0% range in 2023. Below we explore how ultra-low interest rates caused a shift in investor appetite over this period. 

Despite good performance in UK equities since the lows of 2009, investors have gone global. Prior to the GFC, IA Global Equities Sector AUM was around the £12bn mark. That has increased by more than 20 times to over £250bn today. Whilst a portion can be attributed to organic growth, the vast majority has resulted from massive inflows into the space, accelerating markedly in 2018. Meanwhile, assets within the UK All Companies sector flatlined from $95bn to $97bn during the same period, suffering consistent outflows regardless of good returns. 

One explanation for this dramatic shift from UK to global equities has been the dominance of tech stocks. Because equities are priced according to earnings forecast models using an interest rate to discount future cashflows to a present value, near zero interest rates make for a lower discount rate and therefore a greater present value. Growth stocks, such as tech, become especially attractive in such a low-rate environment due to the high growth in their forecasted earnings. This, along with the economic tailwinds of low cost of capital for businesses and consumers has benefitted tech stocks more than any others, drawing in investors and further fuelling performance in the space. 

The growth in price earnings ratios (which measures a company’s share price as a multiple of its earnings per share) of some of the world’s largest technology companies since interest rates were cut to record lows illustrates how much more investors are willing to pay for growth stocks during an era of loose monetary policy. The P/E ratio of Apple has increased from 17 in 2009 to 31 in 2023, representing an increase of over 80% in what investors are willing to pay for the company’s earnings (which themselves have increased significantly over the period). The below table illustrates the growth in price earnings ratios of some of the world’s largest technology companies since 2009. 

*Figure from 2011 due to Tesla IPO being in 2010. **Figures taken from 2010 due to both companies having a P/E of 0 in 2009. ***Figure taken from 2013, the year of Meta IPO. 

Whilst recent interest rate rises from record lows back to more “normal” levels have unwound large parts of recent share price gains and price earnings growth of many tech stocks, the peak P/E ratios that were reached during the period demonstrate just how much the valuations of these companies benefitted during the last 15 years. This has led to their domination in global equity benchmarks. As of the end of August 2023, the combined market caps of Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla and Meta accounted for a larger portion of the MSCI All Countries World Index than the collective stock markets of the UK, France, China and Japan. 

Low interest rates have also had a significant impact on the property market, keeping mortgage rates lower than in previous years and therefore relatively affordable for a larger number of homeowners. However, this has resulted in a consistent rising in property prices, in turn leading to lower affordability. This issue was then compounded by the pandemic, with a lack of production during lockdowns and supply issues hampering a recovery in the aftermath. According to Schroders, house prices measured as a multiple of average earnings have not been this expensive since the late 19th century, when they were also around the 9x mark. House prices have however retreated in recent times, with Savills estimating a 7% slide since the Autum of 2022 amidst a backdrop of tightening monetary policy, as well as Liz Truss’ mini budget which  

saw bond yields surge. The property firm expects another 3% fall in valuations in 2024 before returning to growth in the following year. 

As well as for consumers and businesses, low interest rates have meant a low cost of borrowing for governments, causing national debt levels to balloon. The increase in debt levels accelerated significantly during the pandemic, when the UK government embarked upon huge stimulus programmes in order to prevent economic collapse. As well as a quantitative easing programme from the BoE, the government enacted a furlough scheme to support employment and funded the vaccine programme, both costing billions of pounds. By comparison, in 2008 interest rates were above 5%, therefore the BoE could make significant cuts to provide economic stimulus. However, in 2020, with rates already at record lows, monetary and fiscal policy had to go a step further in order to provide support, causing UK government debt to leap to just under 100% of GDP in 2023 from 50% in 2008. 

After such a prolonged period of loose monetary policy followed by a fast tightening, the question now for investors is what comes next? Given lingering inflationary pressures, it is unlikely that the UK will return to such a low interest rate environment for the foreseeable future, instead staying at a more “normal” level seen prior to 2008. This will inevitably have implications for investors, including changing the dynamic between the equity and bond markets, with the 60/40 approach to portfolio management now no longer looking as dead as once declared. Amongst other things, increased interest rates are also likely to have a continued impact on the property market, with a decrease in demand for mortgages harming house prices, therefore increasing demand for rental properties, in turn increasing costs for renters.