by Tom Bradley
Interest rates mean different things to different people. If you own a home, or want to buy one, mortgage rates are the focus. If you’re retired and looking for income, you care about yields on bond funds and other fixed income products. But the impact of interest rates goes far beyond these two scenarios. They are a key variable in how the economy works and investments are valued.
If rates are stable or declining, we take them for granted and tend to overlook the positive impacts. When they increase meaningfully, we notice. The effects are far reaching and play out over many months.
Think about what we’ve experienced since early 2022. When rates jumped, the first order effects were felt immediately. Higher yields translated into lower bond prices which led to negative fixed income returns. The impact on stocks was less precise, but just as immediate and decisive. Equities were down significantly in the first half of 2022.
As a reminder, stock valuations are based on the expectation of future earnings (and dividends). The interest or discount rate is a key variable in determining what those earnings are worth in today’s dollars. The lower the rate, the more valuable future profits are. An extreme example of this occurred in 2021 when near-zero rates benefited unprofitable companies that might eventually be profitable. The time value of money was low. Now, with the discount rate higher, the focus is on current earnings and less on what might be.
But fully transitioning to higher rates takes time. Private investments, including real estate, are adjusting in slow motion. Transaction volumes are low and the gap between sellers and buyers is wide, such that re-pricing assets is taking time. And we’re just starting to see the impact on parts of the economy, particularly those sensitive to borrowing costs including consumer spending and capital investment (housing; infrastructure; mergers and acquisitions).
Nobody can be sure where interest rates are going from here. The search for stability, and possibly lower rates, will likely have more twists and turns as the narrative on inflation and rates swings back and forth. What we can say with some confidence, however, is that today’s rates are more ‘normal’ than they were two years ago. Perhaps the often-used expression, ‘higher for longer’, which implies rates will eventually go back down, should be revised to ‘back to normal’ (or something cleverer).
The ‘normal’ comment relates to my first piece of advice. Don’t make decisions based on the hope that rates will return to 2021 levels. They may go down, but returning to those levels is not the most likely scenario.
Second, pay attention to the debt side of your family balance sheet. We always encourage clients to look at their overall financial situation when making decisions in their Steadyhand portfolio, and that is more relevant than ever. You should try to stick to your long-term investment plan, but the priority may need to be paying down consumption-related debt (credit lines and credit cards) and reducing mortgage payments.
And finally, expect us to take advantage of opportunities that may arise from any financial dislocation. If there is a recession and/or debt crunch (I emphasize ‘if’, as this scenario is by no means a given), your portfolio is well positioned to provide liquidity and take advantage of higher bond yields and lower stock prices. You can be sure, too, that we’ll live up to our name and be here for any advice, explanations, or assistance you may need.
I encourage you to read the rest of our Q3 Report, where we provide more details on our specific strategies and what we've been doing in each of our funds.
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