Article:

Interest rate rises and foreign policy: the impact of the economic cycle on investment

27 November 2018

Morgan Papi, Associate Wealth Adviser |

The Global Financial Crisis (GFC) was the worst financial crisis the world has known since the Great Depression ended in 1939, and September 2018 marked the 10-year anniversary of when it all kicked off with the collapse of Lehman Brothers.

It may have taken 10 years, but on the back of low interest rates and the ongoing injection of liquidity into global economies through quantitative easing (i.e. central banks buying government bonds and other bank owned securities), the world has recovered and is in the best shape since the GFC. These measures have finally brought us to a point where listed companies are favouring reinvestment into their business/services, technology and staff, ahead of returning profits to investors through dividends or reducing debt (further). Consumers are also more willing to spend money (as illustrated by the rapid rise of Afterpay) and small business owners are as optimistic about the future as they were prior to the GFC.

Unfortunately, we cannot have our cake and eat it too. Low rates and quantitative easing have given rise to a potential price bubble, driven by the accessibility of cheap finance and excessive investment risk taking, as investors chase better returns than current term deposit rates. Accordingly, the two biggest market risks in the short-term are interest rate rises and Trump’s foreign policy.

Interestingly, these risks are inversely correlated. If a trade war between the United States and China escalates, the world economy may slow and in the short-term we could see a market price correction, although further interest rate rises would likely to be off the table. Alternatively, a de-escalation would put investors’ focus squarely back onto interest rates. The risk being that when asset classes like bonds and other fixed interest securities offer higher yields, investors are likely to reduce exposure to equity markets, given that better risk-adjusted returns are available from ‘defensive’ investments.

Either way, increased volatility and market corrections should be expected, but it’s important to put this into context. Ultimately, interest rate rises are a positive signal as it means the economy is growing, but there has never been a period of time where political risk was not present. In the past two years alone, we’ve been subject to Brexit, the North Korean conflict, Trump’s trade wars, and the list goes on. There will always be something else on the horizon, and yet the world will keep turning.

However, given that we currently appear to be at an inflection point in the economic cycle, we continue to take a cautious approach to investing and are prepared to leave some potential returns on the table, if it means avoiding the pitfalls that too much risk exposure may bring. There could be a few more bumps on the road ahead than there have been in recent years, however we expect these will invariably wash out with broader long-term synchronised global growth in conjunction with a disciplined investment approach.

If you have any questions about your investment decisions, please contact us.

Disclaimer:

The information in this document reflects our understanding of existing legislation, proposed legislation, rulings, etc., as at the date of issue. In some cases, the information has been provided to us by third parties. While it is believed the information is accurate and reliable, this is not guaranteed in any way. The information is not, nor is it intended to be, comprehensive or a substitute for professional advice on specific circumstances.

The financial product advice or information in this document is of general nature only and has not taken into account the investment objectives, financial situation or particular needs of any particular person. Before making an investment decision on the basis of the advice above, a prospective investor needs to consider, with or without the assistance of a professional adviser, whether the advice is appropriate in the light of their particular investment needs, objectives and financial circumstances.