The financial markets and the global economy have been driven by accommodative monetary policy for the last four decades. Despite a general decline in interest rates sine the 1980’s, they have dropped significantly since the 2007-08 Great Financial Crisis due to negative demand shocks which lead central banks to reduce rates and implement other monetary stimulus measures. These low interest rates stimulated growth, provided support to global financial markets, and ensured market stability. Moreover, they encouraged investors and decision makers to take on more risk by utilizing leverage (borrowing) in their pursuit of higher returns.
Consequently, there was a corresponding increase in returns on stocks, real estate, and other risky assets. Fixed income securities were benefactors from declining rates and thus extended the bull market that began in the early 1980’s. Low interest rates also resulted in in a narrowing of net interest margins for banks. Combined with regulatory requirements for higher capital levels following the 2007-08 Financial Crisis, this led to a relative contraction of the banking sector. This retrenchment of traditional banking benefited capital markets which experienced rapid growth in North America. It caused a significant shift towards market oriented financial structures.
Initiating accommodative policy, or easy money, is much easier than stopping it. The gradual withdrawal of monetary assistance is not a simple of straightforward process. It causes periodic instability in markets. As interest rates increase, borrowing becomes more costly and this leads to market participants to reduce their leverage. Central banks focus on the reduction of inflation and as we’ve witnessed, rebuild their credibility. When we enter periods of sluggish economic growth, leverage most often declines because higher rates benefits lenders at the expense of borrowers. For years when rates were low as well as corresponding returns, there was pressure on mutual funds to lower their fees which spawned a need for lowering costs and the advent of passive investment strategies. The end of this cheap money and its implications for increased market volatility have a most favourable effect on “active strategies”. Investment firms begin to focus on variations of inflation protected bonds, insurance-based products, derivatives, and a selection of other synthetic products. The issue here is often increased fees and the need to do one’s due diligence before indulging in said products. Generally, when there is reduced support from central banks, market valuations become more varied enabling stock pickers and value investors to identify best opportunities.
Today, the increased volatility we are witnessing in the equity market has led to a resurgence in money market mutual funds (MMF’s). These funds become attractive to investors due to their ability to offer higher interest rates. As was the case in 2022, when investors even experienced losses in their existing bond portfolios, they often choose to liquidate parts of their bond positions and in invest in MMF’s. 2022 and 2023 has seen a significant inflow of investor funds into MMF’s. Surprisingly, mutual fund companies still charge significant fees for these funds improving the economic feasibility of MMF’s. The often-missed opportunity for the retail investor here is making the key switch from MMF’s back to bonds & debentures before interest rates (aka Central Banks) begin to reverse course.
Private equity is an asset class that is sometimes pulled out of the hat during times of uncertainty. Buyer beware. Private equity is facing less favourable prospects due to higher interest rates. Buyout firms are experiencing a noticeable decline in both volume and valuations due to their reliance on increasingly expensive debt. Unlike public markets, private markets are slower to adjust pricing which makes them more susceptible to mispricing and sudden fluctuations. It is not uncommon for surprises to occur in this sector.
What do we value as a committed and forward-looking firm 5-10 years out:
In the coming 5-10 years, it is crucial for all professionals and investment firms to proficiently handle and adapt to more intricate scenarios and evolving conditions all the while prioritizing client satisfaction and fulfilling fiduciary responsibilities.
- Personalization will be key
- Continue our customized approach
- Identification of key thematic global changes and portfolio integration
- Sustainability leadership
- Net zero identification and leadership/low carbon
- Stick to our knitting of well-engineered actively managed, low cost equity and bond portfolios with a global content.
The economies of the world remain under a massive post Black Swan event. Many have reached out wondering why rates have not reversed and rest to pre-pandemic levels. There are a host of reasons. If you haven’t been able to obtain satisfactory answers or feel unable to find a proper plan to navigate what we believe will be a critical decade ahead, please put your legacy as a top priority on your to do list for the end of 2023 or 2024 and reach out now.
Change is the law of life and those who look to the past or present are certain to miss the future. John F. Kennedy