Is a stock market crash imminent as interest rates rise?

It looks like the Bank of England will raise interest rates in the coming months. Nothing is guaranteed. But based on recent rhetoric, analysts think the central bank could raise interest rates before the end of the year, or in the first half of 2022. Unfortunately, there is a chance that this could lead to a stock market crash.

Many risks

Over the past ten years, equity markets worldwide have risen, thanks in part to low interest rates. These make it more attractive to borrow money to invest and can drive up company valuations.

With consumers earning next to nothing with their money in savings accounts, many have also switched to stocks in search of better returns. If interest rates rise, these investors may not stick around.

Higher interest rates can also stress the economy. Debt companies may struggle to meet higher interest charges. This could lead to an economic slump, which would be bad news for equities.

Simply put, there is a range of different risks that can cause a stock market crash after an interest rate hike. The bad news is that at this stage it is impossible for me to say whether a rate hike will cause a crash. Trying to predict the future direction of the stock markets is a foolish message. And it can be downright dangerous when money is at stake.

Therefore, diversification is the approach I use to protect myself from the potential market crash.

Stock market crash protection

I’ve bought stocks for my portfolio that need to continue to thrive, whatever the future holds for the macro economy. These include companies such as Diageo, which have a stronger balance sheet and can pass on higher costs to consumers. Although due to the company’s association with alcohol, it may not be suitable for all investors.

Companies like Rio Tinto can also provide protection against higher rates. This company has a strong balance sheet and commodity prices should match inflation in the long run. That said, commodity prices can be incredibly volatile. There is therefore no guarantee that the group will be able to escape economic turbulence. Still, I would buy the stock to diversify my portfolio.

In addition to acquiring these companies, I would also avoid companies that are struggling in a higher rate environment. A good example is SSP group.

This foodservice group entered the pandemic with weak balance sheets and suffered from the closure of most of its airport and train stations. It could continue to struggle as rates get higher. That said, if the economic recovery continues to gain momentum, the stock’s recovery could also accelerate.

By using the above investment strategy, I believe I can avoid the worst effects of a stock market crash if it does occur. If not, I think the high-quality companies outlined above will continue to perform.

Rupert Hargreaves owns shares of Diageo. The Motley Fool UK recommended Diageo and SSP Group. The opinions expressed about the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a wide range of insights makes us better investors.