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It’s the start of a new financial year and I’m deciding what to do with my annual ISA allowance. Should I keep it in cash or invest it in the stock market?
High inflation and rising interest rates are one reason to think that stock prices might be falling. But I see now as a good time to invest in stocks.
What’s next for the stock market?
Since the beginning of the year, the FTSE 100 has risen 1.5% and the FTSE 250 It’s down 2%. But there are reasons to think that prices will come under increasing pressure this year.
In the UK, interest rates have been rising steadily, creating a headwind for share prices. And I can understand why many think this is likely to continue this year.
Interest rates have been rising as the Bank of England tries to bring inflation down to (close to) 2%. Unfortunately, there are a couple of problems here.
The first is that it doesn’t seem to be working. The most recent reading recorded inflation moving higherfrom 10.1% to 10.4%.
Second, the area where prices appear to be stubbornly high is food. Higher interest rates don’t really have much of an impact here: people don’t stop eating because the returns on cash are higher.
So I think that interest rates could continue to rise, and this could be a problem for stock prices. Despite this, I also believe that now is a good time to invest in the stock market.
What matters when buying stocks
When I look at how the best investors approach the stock market, they don’t base their decisions on interest rate forecasts. Also, they do not make predictions about what stock prices will do in the coming months.
For the best investors, like Warren Buffett and Howard Marks, these are not the things that matter. The important thing is to buy shares of companies at prices where future returns look good.
Whether or not a stock is trading at an attractive price comes down to how much money the company is going to make. Any company can be a bad investment if its price is too high for its future earnings.
So the question for investors like me to consider is whether the stock market is allowing opportunities to buy shares in companies that are low compared to the cash they produce. And I think it is.
The FTSE 100 is currently trading at a price-earnings (P/E) ratio of 11, implying a 9% return on earnings. And the P/E ratio of the FTSE 250 right now is 10.5, which means an earnings yield of 9.5%.
None of these seem particularly expensive to me. As a result, I think there is likely to be some good opportunity right now for investors.
Find stocks to buy
I’m not saying that stock prices won’t go down for the rest of the year. I don’t think it’s possible to know what stock prices will do, so I can’t rule it out.
The FTSE 100 and FTSE 250 trading at low P/E ratios don’t tell me which stock to buy. It tells me that there are probably good investments to be made. But my job as an investor is to find out what they are.
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