We have all seen rising rates over the past 13 months. Interest rates have gone from zero bound all the way to 5%. This has had some significant impacts across the entire economic landscape. With higher borrowing cost on variable interest rate loans lowering access to capital, it is safe to say that the economy should be experiencing a contraction, however, the economic numbers have still come in quite favorably. With employment remaining strong and inflation undesirably high, the Fed will continue to increase rates. So what does that mean for your assets?
The front end of the yield curve has provided much needed relief to short-term savings, with the curve well north of 4% for anything less than a year in length. Savers can stock money away at a safe return without fear of actual loss as long as held to maturity in treasuries. Money market rates have also seen increases in yields as well. The reason for this is the natural desire of the Federal Reserve to push money out of the economic system and slow inflation. The larger impact is on the overall health of markets and the economy.
So what happens next? As a manager of money for many of my clients, it allows for managers to seek assets that can offset risk. The risk is that the market will need to reprice in the interim facing higher rates. What is repricing? It is just a fancy word for “going down”. The real question is why does the market need to reprice?
The reason that markets tend to reprice on rising rates is the fact that growth needs to be discounted. The high price-to-earnings dedicated to growth with lower rates will be impacted by rising rates. I can go through an esoteric formula and explain the overall dynamics around discounting, but I would rather not bore you death. I will just say higher rates generally mean lower valuations for growth.
The most important reason why markets “should” continue to reprice is the fact that you can now get 4%-5% return in government securities absent additional risk. So to put it plainly, the market needs to provide the investor more than 4%-5% guaranteed before an individual would think about investing in equities. The logic goes back to modern portfolio theory and investor behavior. If I can receive a 4%-5% government security between 0-10 years absent risk outside of government default, the market would first need to compensate me for the additional risk I am willing to take.
As you know our philosophy, we are long term investors that strive to attain risk-adjusted returns. Maintaining our investment in the face of down markets is key and removing the urge to sell in bouts of volatility remains key.
Higher rates “may” continue to impact markets over the short-term due to investors moving money into safer instruments at higher yields. The design by the Fed is to entice savers into safer assets and out of markets, while also bringing down their capacity to spend which in turn lowers inflation. This is something that will take much longer than the federal reserve anticipated, and likely at much higher yields than anticipated. There is one thing for certain, “Time Will Tell”!
9i Capital group LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.