Normalising interest rates is a good thing because it signals a normalisation of the environment.
We are experiencing poor markets at the moment and it helps to remember that ‘now’ has happened many times before and a lot worse.
No one likes seeing markets fall; the up, up and away days of 2012/13 were great fun and checking portfolio values to find them higher each time was great for the mood.
It’s possibly hyperbolic to say that such times as these are when investors are truly tested, but there is some truth to the statement.
Listening to commentators and reading the press is to hear endlessly about Russia and the Ukraine, Israel and Palestine, Iraq, impending interest rate increases in the UK and US and the African Ebola outbreak. It’s all negative and it’s all depressing.
But if we look a little closer at each of the above situations and also factor in the big picture global economic trends, things are not quite so terrible.
There have been 18 previous Ebola outbreaks in the last 20 years and none have become globally serious.
Russia and the West are posturing and flexing their muscles and in the case of Russia actively reasserting their status as a dangerous global power (which is playing wonderfully with their electorate) but it’s all highly unlikely to go beyond the economic.
If one compares the big global powers (US, China, Russia, EU) to big football clubs such as Man Utd, Liverpool, Arsenal and Chelsea they all equally dislike each other, take huge delight in beating one another and their supporters are tremendously tribal. The point is that they are co-dependent, they have to play in the same league and it’s not realistic for one of them to isolate themselves from the others as they would have nobody to play against.
This is the same with the 21st century interconnected global economy. So we can fully expect China to play difficult with the US (import bans, copy write infringement, cyber-attacks etc), or Russia to play hardball with Europe over gas imports or former Soviet bloc countries but it’s a game of marginal advantage where each can go so far but there are fundamental limits which make absolutely no sense to go beyond.
The Israeli issue is as old as we know, it’s indeed properly biblical. It will be a problem until the two sides decide to live in harmony which is not any time soon. It will flare up and die down and each time the polarisation will become a little greater.
The US will continue to support Israel (come what may) as an ally in the region and because of the power of their Jewish political lobby. This is to make no judgement; it’s just how it is.
The Palestinian problem in a broader context is the greater Middle Eastern issue of a fundamentally Islamic Arab region which is culturally hostile (in the main and with some justification) to the West.
This mattered to the US a lot post the Second World War because of its increasing dependence on imported oil, it matters much less now with their discovery of huge domestic oil and gas reserves (the US is now the largest producer of oil).
The current problems in Iraq are largely as a result of the US invasion (which was mainly oil motivated).
It’s absolutely right to condemn and detest the behaviour of a Saddam Hussein or a General Muammar Gaddafi but their rule of domestic terror was partly to keep control of a tribal and religiously divided populace.
Take away the control (barbaric as it was), create a vacuum and then leave; and then instability and factional infighting is what results. (Tito and Yugoslavia was no different; a vacuum led to civil war which eventually led to the region being divided into a number of different countries).
The final negative current headline is the economic (not geopolitical) question of when do interest rates start to rise in the UK and US?
With TV channels dedicated to business news and newspapers needing daily content this is the story that will keep giving. Every speech and meeting notes from Fed chief Janet Yelland or BOE head (gorgeous George) Carney are avidly parsed for clues, will it be March 2015, maybe April, could they bring it forward to late 2014?
The realities of interest rate rises are.
1. It’s definitely going to happen at some point (probably around mid-2015)
2. The Central banks will give the markets ample warning and will go slowly
3. Stock markets historically rise in periods of interest rate rises
4. There will be an initial wobble when the first one is announced but markets will get over it
5. The bond and housing markets will not enjoy rising rates
6. Normalised rates will be at around 3-5% going forward, this compares to the average rate in the 1990’s of 12%!
7. The great bond investment period will be over, this is cyclical and equities with growing profits and dividends will be more attractive until rates peak out
8. The crucial point is that the world’s economic growth is normalising and the Great Recession of 2008 did not thankfully morph into a Great Depression with deflating economies and mass social unrest
Normalising interest rates is a good thing because it signals a normalisation of the environment. The economic numbers from the US are strong, China seems to be improving, Europe is still fundamentally flawed and has social costs which will hobble it but it’s manageable and Japan is doing all it can to break free of stagnation.
All is not perfect but it’s workably imperfect.
As we have often parroted, the next big problem is something we could not have foreseen and the times of greatest danger are when most perceive no imminent threats.
The world is now hyper vigilant to bubbles and mis-pricing (post 2008) and fundamentally there aren’t currently any significant areas of concern (high yield debt, new internet stocks and biotech are somewhat bubbly).
Stock market average valuations are around historic fair value.
Property prices are strong but not off the chart, and interest rate rises will moderate growth as will tighter mortgage rules.
Commodities are not expensive.
Bonds will be a poor investment over the medium term if bought now but anyone with basic common sense knows this already.
The chase for yield which has caused high yielding debt to boom will dissipate, and likely the funds will in time flow to equities with rising dividend yields.
The world can be a dangerous place and humans are tribal and violent but it’s not like that’s ever been different (or likely to be different) and we’ve all made it to here ok!
NOTE: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.