We should cheer, not fear, rising interest rates
So-called experts have been deployed to explain why financial markets are turbulent. A cornucopia of financial terms, one more opaque than the next, has been expressed to help interpret wild moves in index values.
All of this is noise that connects with negative shifts in financial market values. You may note that there were few, if any, headlines as equity markets stormed upwards during 2017.
It seems that a rise in equity markets, being good news, is not deserving of mass media attention. Only the negative stuff gets the hairdryer treatment.
Rational investors, be they large institutional money managers or an individual managing his or her long-term savings, should take all of this with a pinch of salt.
Instead of obsessing in front of 24/7 news channels, investors should stand back and consider some hard facts.
Fact number one is that the US equity markets remain 15% above where they were just 12 months ago, even after the turmoil last week.
That advance in share prices compares with inflation at low, single-digit percentages and interest rates close to zero.
This, in turn, tells us that investors exposed to equities have made real returns of over 10% in the past year, a remarkable growth rate compared to long-term trends.
Fact number two is that interest rates, globally, have stopped falling and, in some regions, have started to rise. For almost 30 years, interest rates, and related bond yields, have been falling.
That has had a profound effect on how various financial markets have evolved.
Low interest rates drove investors away from bonds and towards other asset classes, including equities and property. These asset classes have benefitted enormously from these trends.
At the same time, pensions have been hammered, as low interest rates made defined benefit schemes, in particular, stressed, as the quantum of money needed to keep them solvent exploded.
In fact, very low interest rates created massive pension deficits that threatened corporate and government finances.
Now that interest rates are starting to rise, structural changes in financial asset values are inevitable. These interest rate increases are occurring for largely good reasons.
Economic growth is picking up, as is inflation. Governments worldwide use interest rates to keep a lid on inflation and aim for moderate, long-term growth.
Low interest rates for the past ten years are emergency rates caused by the global financial crisis. Instead of panicking about higher rates, we should be cheering them.
Rising interest rates are also pushing up bond yields. Long-term bonds in the US are now paying out almost 3% and should rise further in coming years.
As these yields move up, investors will demand higher returns from competing assets, such as equities.
Hence the vibrations last week. Dividend yields on shares are, on aggregate, at multi-year, low levels and this has to change, if bond yields are on the up.
These gyrations are yet another sharp reminder of the importance of diversification.
Anyone with a savings or pension pot should, at all times, have their investments spread across a range of assets, including bonds, equities, cash, property, and commodities.
These assets should be, in part, chosen to generate annual cash income that allows the underlying capital to work, while regular income satisfies monthly and yearly bills.
Such a portfolio approach helps dampen the hysteria evident in recent days.
As an extreme example, anyone who owns an Irish property probably, in the past week, enjoyed a slight rise in value, while equity markets fell 10%.
A properly balanced portfolio mitigates the swings in value evident across individual assets and keeps sleepless nights to a minimum.
