The Bank of Canada started increasing interest rates in April 2022. While interest rates keep changing, they had more of an impact this time as the central bank grew them aggressively from 0.25% in March 2022 to 5% in July 2023. Such sharp rate hikes have significantly increased mortgage interest payments. Consequently, all companies with large debt saw their stock prices fall as rising interest expenses affected them. Some even slashed dividends to pay mortgages.
While higher interest rates brought higher income to banks, they also increased credit risk. Fear overpowered optimism, and bank and lending stocks fell throughout the rate hike cycle. When a significant portion of your income goes into debt payment, you spend less on discretionary items or postpone your purchases. Consumer demand fell, and stocks of discretionary items like automotives took a hit.
Waiting for interest rate cuts
Now that Canada’s inflation has eased to 3.1% in October, the Bank of Canada has paused interest rate hikes. The rate has remained unchanged at 5% since July. Numbers show that the bank could start rate cuts in early 2024. This optimism will become more prominent after the December 6 meeting of the Monetary Policy Committee. Some strong upside momentum is likely in early December. Thus, smart investors are buying stocks that could benefit from interest rate cuts.
Where are smart investors putting their money?
A smart investor would take a top-down approach in this scenario since the macro environment is affecting company balance sheets. Lower interest rates could bring some relief to high-debt companies, which means stocks that fell through the rate hike cycle could reverse their trend next year.
The correlation between BCE and interest rates
BCE’s (TSX:BCE) stock fell 30% between April 2022 and October 2023. The stock price fell over 6% after the Bank of Canada increased its interest rate from 4.75% to 5% on July 12 and surged 4% after it retained a 5% rate on October 25. The interest rate decision has reversed BCE stock’s momentum. Since the interest rate has peaked, it is fair to assume that BCE has reached its bottom.
The reverse trend will likely begin in 2024 with interest rate cuts and a BCE stock price surge. A lower interest expense will also relieve stress on the telco’s distributable cash flow and help it sustain the 5% dividend growth rate.
The correlation between gold and interest rates
Like high-debt companies, gold also has an inverse relation with interest rates. When interest rates rise, the value of the paper currency rises. The substitute for paper currency is gold, which has a store of value and is a globally accepted means of exchange. Even central banks store gold reserves for difficult times. Thusly, gold moves in the opposite direction to the dollar.
Barrick Gold (TSX:ABX) stock is showing early signs of a reverse trend in interest rates. The stock has surged 21% since the beginning of October as inflation eased and interest rates remain unchanged. The gold stock will likely surge as central banks worldwide cut interest rates. It happened during the 2020 pandemic, the 2008 Financial Crisis, and the 1980s crisis. In all crises, gold prices surged significantly after interest rate cuts began.
Lower interest rates increase the money supply in the economy by making borrowing cheaper. And anything in abundance sees its value drop. When the interest rate falls, the dollar weakens, and gold strengthens. As the owner of one of the largest gold mines in the world, Barrick Gold holds gold as inventory. So, its stock price moves in tandem with the gold price as it can get a higher value for its inventory.
Investor takeaway
The stock market is at the cusp of a turnaround. Understanding the correlation between different types of stocks can help you benefit from this shift.
