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A growing counsel of doom has been warning about the end of the zero-interest rate era, that apparent Eden built on an abundance of cheap capital and easy funding rounds for the tech sector. Many now look back wistfully on the last decade as a kind of financial nirvana. In fact, their argument is compellingly simple: If low rates boosted asset prices, then higher interest rates should depress valuations.
It’s a nice narrative, but there isn’t any evidence to support it. Yes, the initial impact of low rates is always a crowd-pleasing elixir. But the longer-term impact of low rates, particularly if they remain low for long periods of time, always leads to lower growth. The reasons why are long: Low rates hinder the process of creative destruction, lower the incomes of retirees and savers, and contribute to widening wealth inequality and a shrinking middle class. Most importantly, low rates discourage saving, investment, and capital accumulation — crucial props for lifting productivity and longer-term growth.
In the 2010s, the need for consumers to repair balance sheets necessitated a far lower interest rate. An extended period of debt reduction, cleansing of excesses and overall financial system repair was needed. Today, we simply do not have the same economic and financial imbalances. Generally, the global economy is on far firmer footing and several dynamics are different: well-capitalized banking systems; healthier consumer balance sheets; and, most importantly, rising wages and robust labour markets. The big surprise will be that the global economy can handle higher rates without tipping into a deep and protracted downturn similar to the one after 2008.
Much of today’s asset pricing still reflects the disinflationary and ZIRP trends of the last 40 years. Several investments flourished in the long era of low, dull interest rates. Mispriced assets can be seen everywhere. Growth stocks, with their pricing based on ultra-low discount rates, are the most obvious example. Residential real estate in Canada, Australia, and Sweden are another (as a share of disposable income, debt levels in these countries sit at 185%, 202%, and 203%, respectively).
Privately held, illiquid assets are also flashing red. Most were structured when capital was free. In a higher interest rate environment, many are no longer viable. Next year will face a reckoning, as venture capital and private credit still do not reflect the re-pricing of the risk-free rate, let alone any economic weakness.
Having wandered through a desolate landscape of low yields over the last decade, interest rates are now normalizing. Money managers should welcome this. And, whereas the 2010s mantra was “lower for longer,” the new one for this decade will be “higher for longer.” The good news is that the world has just witnessed one of the fastest yield restorations in history. That means higher returns can also be had – but only if investors reorient portfolios away from those investment classes that needed zero rates to thrive and towards those that have languished over the last decade.
Several high-income candidates exist here: global dividend-paying stocks; emerging market bonds; and, even resource stocks, which are paying out a huge portion of their profits in the form of dividends.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. The Forstrong Global Investment team contributed to this article. This article first appeared in Forstrong’s “2023 Super Trends Report: Metamorphosis” publication available on Forstrong’s Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at tmordy@forstrong.com. Follow Tyler on Twitter at @TylerMordy and @ForstrongGlobal.
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Content © 2023 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.
The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.
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