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The last few years have seen a bull market in recession predictions and a booming trade in the wider apocalypse forecasting genre. Engage in any of this and Milton Friedman’s famous pronouncement that the effects of monetary policy are subject to “long and variable lags” will worm its way into the conversation. And the logic seems sound. Higher interest rates take time to impact the economy.
If only it were that simple. Many are now looking back wistfully on the 2010s as a kind of economic Eden built on an abundance of cheap capital and easy funding rounds for the tech sector. That symmetry is seductive: If low rates boosted asset prices, then naturally, higher interest rates should depress valuations. It’s a nice narrative, but there isn’t much 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. Why? For one, low rates hinder the process of creative destruction. They also lower the incomes of retirees and savers, who are then forced to suffer from negative real returns on their fixed income instruments (what Keynes colourfully called the “euthanasia of the rentier”). The net result is widening wealth skews and a shrinking middle class – trends that impede inclusive and broad-based economic growth.
Most importantly, low rates discourage saving and investment. But capital accumulation is crucial for lifting productivity and longer-term growth. Consider that the 2010s were the decade of massive stock buybacks. That makes sense. Why would companies, even those flush with cash, engage in real business investment when growth is uncertain, and capital near-free? As it was, a capital spending cycle, with the resulting rising wages and higher growth, never took hold over the last decade. Instead, the recovery from the 2008 financial crisis was the most anemic since World War II.
Looking back, the low interest rate 2010s were merely a reflection of slow growth and low inflation. Deleveraging in America and the Eurozone was the main event. Many forget that the global economy limped through that decade, with only a narrowly concentrated set of asset classes doing well.
Of course, a higher cost of capital will still create damage. The key is to identify genuine monetary shocks and trace their effects through the real economy. Using this framework, higher rates are indeed hammering certain asset classes where the most leverage and credit excess took place.
Long and variable losses are happening. Cryptocurrencies and profitless tech, fueled by near-free money, have already collapsed as hot money fled the sector in 2022 (don’t be fooled by bear market rallies in 2023). Commercial real estate is in recession. Canadian housing, along with other developed markets that did not deleverage in the 2010s (the U.K., Sweden, Australia, etc.), are – look away homeowners – facing falling prices. And the massive wave of capital that flowed into private markets, previously unburdened by pesky things like transparency, are now facing a painful price discovery process (read: much lower).
But these are all relatively limited pockets of global markets. Commercial real estate is a wealth shock, but the impact on consumption will be limited as owners are skewed toward institutions, pension funds, etc. Housing in weak-link economies will likely produce recessions but these countries collectively account for only about one-tenth of global GDP. Healthy wage gains will also help offset the downside here. Finally, the fallout from private markets will have limited contagion on the broader banking sector as regulatory reform after 2008 forced them away from speculative lending.
Looking ahead, the move away from the zero-interest rate era and the normalization of monetary policy should be seen as a positive development. This also comes at a time when the world is far less interest-rate-sensitive than it has been in decades. America and the Eurozone have far healthier household balance sheets. In Asia, even though China’s blistering GDP growth rates are over, pessimism toward the country is overdone. Incoming economic data in recent months are now starting to consistently surprise on the upside. Collectively, China, America, and the Eurozone account for some 80% of global GDP. Deep global downturns are unlikely, particularly if rate hiking cycles are now over.
Monetary action isn’t always the main event for investors. The Fed cut rates by 500 basis points in 2007-08 and stocks promptly plummeted by nearly 50%. Then, the Fed raised rates nine times from 2015 to 2019 and shrunk its balance sheet. The S&P 500 more than doubled over that period. Trends in risk appetite and changing macro dynamics often trump interest rate changes.
The real danger today lies in investor complacency – refusing to change portfolio strategy to align with the new macro fundamentals. During the 2010s, markets were busy pricing in a low interest rate backdrop. That meant technology, growth stocks and all things America steadily outperformed. The reverse will happen in the 2020s. Higher interest rates coupled with a more abundant growth backdrop have changed the calculus.
Investors need to think differently here. A simple framework should guide investors through this new terrain: Minimize investment classes that were reliant on low rates (i.e., nearly everything that did well in the 2010s) and aggressively accumulate productive assets in the real economy with pricing power, and high and rising yields. We are getting back to a world where near-term earnings and cash regularly paid to shareholders matter. When investors can buy a variety of international stocks on single-digit earnings multiples with high dividend yields, speculative stocks start to lose their edge.
Winners in this environment will generally be the value sector, international stocks, and currencies in countries that refused to monetize the Covid crisis. These assets all have the following in common: deeply depressed valuations; astonishingly high real yields; and zero dependence on low interest rates.
Forstrong’s investment team, a collective with several centuries of combined global experience, continues with our best ideas about the world’s most important Super Trends – those enduring themes that will have the largest impact on capital markets. Our hope is that our Super Trends 2024 report will help investors make sense of the unfolding macro landscape and unravel some of the market’s mysteries.
Tyler Mordy, CFA, is CEO and CIO of Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities selection. This article first appeared in Forstrong’s Super Trends 2024. 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 X at @TylerMordy and @ForstrongGlobal.
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Content © 2024 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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