Even the most stoical of investors could be forgiven a spot of collywobbles these days. True, the stock market has been in robust form. The FTSE 100 index of leading shares hit a new all-time high recently, partly propelled by the earnings-boosting impact of a weak pound for our giant multi-nationals. The same cut-price pound that fell in the wake of the EU Referendum has also boosted the sterling value of the non-UK funds and shares that many of us hold in our ISAs and pensions. Can anyone yet say hand-on-heart what impact Brexit will have on…
Even the most stoical of investors could be forgiven a spot of collywobbles these days.
True, the stock market has been in robust form. The FTSE 100 index of leading shares hit a new all-time high recently, partly propelled by the earnings-boosting impact of a weak pound for our giant multi-nationals.
The same cut-price pound that fell in the wake of the EU Referendum has also boosted the sterling value of the non-UK funds and shares that many of us hold in our ISAs and pensions.
Can anyone yet say hand-on-heart what impact Brexit will have on our economy? I remain none the wiser.
Then there’s the international scene. Europe doesn’t seem to be the basket case it once was, but the idiosyncratic style of the US Tweeter-In-Chief has more than made up for quieter dispatches from Italy and Greece.
Oh, and North Korea is testing out long-range missile systems. Just in case you were sleeping too easily!
High ho, high ho
Of course, experienced investors know there are almost always scary headlines out there. It would be hard to sell news without it.
More often than not, of course, the eventual impact on the markets is negligible – and certainly hard to pinpoint.
As Foolish investors, we concentrate on companies much more than the commotion in the media for this very reason.
However, I think there’s a news story of tomorrow fermenting that we should all be aware of – even if we decided that we’re best not taking any action because of it.
Readers, I am talking about the long-awaited bond crash.
Or, less sensationally, the ‘renormalization’ of interest rates.
Or how about just the end of cheap money?
It’s hard to know how to define something pundits have talked about for the best part of a decade, but that for years we’ve barely seen a whisker of.
But central bakers around the world suddenly seem to be singing for the same hymn sheet. It’s a muted chorus, sure, but one where the end of QE and interest rates hitting higher notes than in most millennial Fool’s investing lifetimes seems a likely crescendo.
Don’t stop ’til you get enough
Here’s what famed hedge fund manager Ray Dalio wrote recently in a note widely quoted in the press:
For the last nine years, central banks drove interest rates to nil and pumped money into the system, creating abundant cash.
These actions pushed up asset prices, drove nominal interest rates below nominal growth rates, pushed real interest rates on cash negative, and drove real bond yields down to near zero percent.
This led to more conventional economic conditions in which credit growth and economic growth are growing in relatively good balance with debt growth.
That era is ending.
Dalio says central bankers have now clearly told us they intend to take away the punch bowl from the easy money party. The cost of money is rising, or in other words, expect higher interest rates.
The most immediate and arguably important impact of higher interest rates from central banks would be the impact on bond prices.
As interest rates rise, the prevailing yield you can get from bonds that were priced for the rates of yesteryear looks less attractive. As a result, investors sell those bonds, causing their yields to rise too until they’re more in line with the new rate reality.
If interest rates continue to rise then, all things being equal, that process continues.
I can hear some of you saying: “What do I care about the bond market? I’m an investor in shares!”
Wrong. There are numerous ways this could impact the stock market.
There are no certainties, but the bond market dwarfs the equity market, and the risk-free rate from high-quality government bonds drives the valuation of all other assets.
Warren Buffett says interest rates act like gravity in the markets for this very reason.
Bond’s license to thrill
From the attractiveness of shares versus bonds and cash, to the rising cost of borrowing for companies struggling under too much debt, a sustained rise in interest rates could have consequences for investors of every stripe.
So, higher interest rates – while unpredictable – would eventually make themselves felt in all our portfolios.