Which ASX shares could outperform if interest rates stay higher for longer?

High interest rates won't necessarily hurt all businesses equally.

Blue % sign with white dollar signs.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

The investment landscape has significantly changed over the past two years because of higher interest rates. What could it mean for ASX shares if interest rates stay higher for longer?

Central banks hiked interest rates so that some demand would be taken out of the economy and it would reduce the rate of annual inflation. As Pengana Capital Group Ltd (ASX: PCG) has pointed out, inflation is reducing compared to the peak rate seen in 2022.

However, consumer spending remains stronger than some may have been expecting, with other categories also showing quite strong growth, such as rent and wages.

Pengana suggested that "inflationary pressures are likely to linger due to weak productivity growth, deglobalization, lower levels of immigration and the cost of the energy transition. A higher neutral rate of interest will also impact central bank decisions."

What would this mean for ASX shares?

Debt becomes more expensive as interest rates rise and stay higher, so businesses with substantial debt on their balance sheet could suffer from higher costs and the loss of investor confidence.

We've already seen the real estate investment trust (REIT) sector go through some pain. For example, the Growthpoint Properties Australia Ltd (ASX: GOZ) share price is down over 50% since April 2022.

A tough economic environment may mean some businesses are not able to pass on price rises to their suffering customers, and there may be less demand for businesses related to discretionary spending.

Businesses that are only just able to afford to pay their interest payments may struggle to repay debt when it's due, or fund new investments. These businesses "are likely to struggle in periods of high interest rates", according to Pengana.

Higher interest rates can also play havoc with valuations. As Warren Buffett once said about interest rates:

The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.

Which stocks could do well?

Pengana suggested that businesses that generate positive free cash flow "should fare better" and can enable them to fund growth without needing new debt or to do a capital raising.

The fund manager also suggested that companies with strong balance sheets are less vulnerable to higher interest rates and adverse credit environments.

I'd point out that if a business has a net cash position (or no debt at all) it means that the business could generate pleasing interest income from its cash balance.

Free cash flow and/or a good balance sheet means that a business could acquire a financially distressed competitor and significantly improve its market position during these uncertain times.

Pengana also pointed to some sectors that could be good to hunt for opportunities:

Companies that grow earnings and dividends – through aligning to structural growth trends such as artificial intelligence, decarbonisation, automation, global travel, onshoring or the ageing population – may enjoy greater resilience than those marketing discretionary items to stretched mortgage holders.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Share Market News

Young boy in business suit punches the air as he finishes ahead of another boy in a box car race.

4 things I look for in ASX shares to beat the market

These are the different ways I invest to try to beat the market.

Read more »

A neon sign says 'Top Ten'.
Share Gainers

Here are the top 10 ASX 200 shares today

The ASX 200 started the week off on a positive note...

Read more »

A happy male investor turns around on his chair to look at a friend while a laptop runs on his desk showing share price movements
Broker Notes

Leading brokers name 3 ASX shares to buy today

Here's why brokers believe that now could be the time to snap up these shares.

Read more »

Person pointing at an increasing blue graph which represents a rising share price.
Share Gainers

Why Gold Road, Sayona Mining, Star Entertainment, and WA1 shares are falling today

These ASX shares are having a difficult start to the week. But why?

Read more »

Arrows pointing upwards with a man pointing his finger at one.
Share Gainers

Why Beach Energy, Pact Group, Smartgroup, and Winsome Resources shares are rising

These ASX shares are starting the week strongly.

Read more »

A man in his 30s with a clipped beard sits at his laptop on a desk with one finger to the side of his face and his chin resting on his thumb as he looks concerned while staring at his computer screen.
Technology Shares

Can BrainChip shares reach 30 cents by Christmas?

I'd be shocked if BrainChip got anywhere close to 30 cents...

Read more »

Two happy pharmacists standing together in a pharmacy.
Capital Raising

Own Sigma shares? Everything you need to know about the 'transformational' $8.8b merger with Chemist Warehouse

Here's what you need to know about this mega merger.

Read more »

A happy boy with his dad dabs like a hero while his father checks his phone.

2 ASX shares I'm backing for a big 2024

I think it’s a great time to be invested in these two stocks.

Read more »