Could this be viewed as a “Sea Change”?
Howards Marks, a highly regarded US investor and writer, recently wrote an article reflecting on the possible causes of the investment events of 2022 and compared them to past landscape-shifting events.
In Marks’s view, the actions of the US Federal Reserve in aggressively raising interest rates from March 2022 onwards to combat inflation, may indeed have ushered in a fundamentally different investment world for the future.
Has the investment world seen anything similar to this before?
A ‘sea change’ by its very nature is something that doesn’t happen often. Marks identifies only two comparable previous shifts that had long-lasting impacts on the investment environment, which were:
- when investors in the 1970’s shifted from avoiding risk automatically to managing risk actively in relation to potential returns; and
- the long-term declining interest rate environment that began in the 1980’s (after US interest rates peaked at 20% in 1980 in order to crush inflation at that time).
That declining interest rate environment lasted for forty years
It can be argued that the lower interest rates have provided the greatest impetus to market returns in that time (although in more recent decades, technology advances and globalisation have also contributed to higher returns).
Lower interest rates make it cheaper for consumers to buy on credit and for companies to invest in stock and equipment. Lower interest rates also enable companies with debt to make higher profits. The fair value of asset prices should also rise when future cash flows are discounted at lower interest rates, e.g., a R10 000 receipt in ten years’ time is worth substantially more today if expected interest rates over the period are 2% p.a. rather than 5% p.a. Such rising asset prices can, in turn, create a “wealth effect” whereby people feel richer and therefore spend more, thereby increasing economic activity.
So, if the world is moving away from a falling interest rate and towards rising interest rates instead, it’s going to mean a lot of change.
So, are global investment markets shifting towards higher interest rates?
It seems possible, even likely. And if that is the case, what are the implications for future investment strategies? There are a number of points that come to mind:
- We can reasonably conclude that successful strategies from the past four decades of falling interest rates would not necessarily prove effective in the opposite, rising interest rate environment.
- It seems likely that a high-quality active asset manager should now have a higher probability of outperforming a passive management approach.
- Higher credit (or bond) allocations within offshore balanced funds would be more feasible in a higher interest rate environment.
- There could be increased cash holdings within balanced funds.
- Alternative investment strategies will need to be considered more closely as it may be unreasonable to expect rising share markets to raise all boats.
Where to from here?
At Netto Invest we advocate creating a financial plan that focuses on long-term investment returns, and then revisiting that financial plan regularly to adjust for reality as required. This situation still lends itself to that approach.
Schedule a review with your CERTIFIED FINANCIAL PLANNER® to discuss whether you need to make changes to your investment portfolio to consider these shifts in the global investment landscape.
By Richard Sparg, CFP® CA(SA)
