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How best to describe market vibes in 2022? Investors do not have to look far to see a booming trade in the apocalypse forecasting genre. Take a stroll through the section and all the headlines read like scenes from a Mad Max movie. Energy rationing in Europe. Renewed tension in the Taiwan Strait. Ever-widening political fault lines in America. Then, toss into the plot sanctions, blockades, infrastructure attacks, and embargoes on raw materials, and the category really feels bleak.
Unsurprisingly, all of this has weighed heavily on financial markets. A June 2022 survey showed money managers more bearish than during the market lows of March 2009. That same month also saw the highest stock market volatility since 1928.
But there is a key support to all this gloom too. A growing counsel of doom is now 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 are now looking back wistfully on the last decade as a kind of economic nirvana. In fact, their argument is compellingly simple: 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. When the 2008 global financial crisis hit, Fed Chair Ben Bernanke – an avid student of the Great Depression – was determined not to repeat the failures of the 1930s, cutting the benchmark fed funds rate to 0%. He also introduced a comprehensive kit of unconventional tools, notably, forward guidance and trillions in government bond purchases (which, at the time, Bernanke estimated were equivalent to another 300 basis points of rate cuts). Everyone knows the story from there: Markets initially soared on government wings.
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. Look no further than the Japanese economy, where rates have been stuck at zero for years and where lifeless companies with poor profitability survived on fresh rounds of debt, simultaneously sucking crucial resources from more dynamic companies. Since the early 1990s, the Japanese economy has faced a series of rolling “lost decades.” Another one in the 2020s is likely.
Low rates 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, however, 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 company 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? Over the short-term, corporate executives can hit quarterly earnings targets far more easily with financial engineering than long-term investment initiatives. As it was, a capital spending cycle, with the resulting rising wages and higher growth, never took hold. Instead, the recovery from the 2008 financial crisis was the most anemic since World War II.
What’s worse, the investment that did take place mainly went into productivity-dragging distractions – digital games, social media, and other consumer internet technology. Sure, some of these are modern conveniences, but they are hardly industrial breakthroughs. Compare that with earlier episodes of capitalism, which generated advances in electricity, key infrastructure, and other innovations that lifted productivity across industries.
Yet, for the last decade, Silicon Valley was a huge magnet for talent. Those involved in tech-startups often made a fortune, despite working for companies that never turned a profit or created value for the public. All this, of course, has come with a longer-running cost. For example, in the resource extraction business, we now have a shortage of mine engineers. New projects take far longer to complete. New technology to make extraction faster and more cost-efficient has also been scant.
No surprise, then, that the world is facing enormous deficits in key commodities. A wide range of other research-intensive fields have suffered as well, as endless rounds of low-rate-funded venture capital pushed the best and brightest into game development and ad optimization (and, sadly, into building algos for cryptocurrencies).
Yet now comes a plot twist. Inflation is back and the move away from zero interest rates has come with a significant bear market, crushing asset prices of all types. Investment classes that thrived on low rates, like profitless tech companies have seen trillions vanish as hot money fled the sector.
What happens next? To prevent further market carnage and ever-rising rates, inflation must start to moderate from here. But how will that happen and when? And what are the implications for investors. I’ll consider those questions in my next article.
Next time: How and when will inflation abate, and implications for investors.
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 “2022 Super Trends: World in Transition” 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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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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