After all the speculation that September would host the first rate rise in the US since 2006, the Federal Reserve kept investors waiting again. Holding off was certainly not an easy option. “No change” risks making the US central bank look seriously worried. It is why Fed chair Janet Yellen was at pains to make clear that this is a deferral, not a cancellation – as she said, it’s all about the data.
In reality, it makes little real difference that the Fed opted for a “hawkish hold” over a “dovish rise”. Yellen plumped for no rise with the promise of a hike to come. She rejected the alternative of a small hike now softened by reassuring noises about the pace of future increases.
Actually, they are flip sides of the same coin. The fact is that six and a half years into a tepid global recovery, with an almost total absence of inflation, interest rates are going to stay lower for longer.
So what has brought us to this environment of low growth, low inflation and low rates – what former Treasury Secretary Larry Summers has dubbed “secular stagnation”? And what might it mean for investors?
The unprecedented weak recovery from the financial crisis is a consequence of two trends that were underway long before the events of 2008. These are a chronic lack of demand in the global economy and an excess of savings over investment. For a variety of reasons, too much money is chasing too few opportunities. It stands to reason that the main measures of that relationship – interest rates and bond yields – are low and likely to stay that way.
Demographics, firstly
Why are savings so high? Demographics, firstly, as the population bulge moves into middle age and starts saving for its retirement; then inequality, as the share of global income shifts towards the rich, who are more likely to save than the poor; and finally the growth of emerging markets and the reserves their export-led economic models have enabled them to accumulate.
And why has investment gone the other way? Technology, largely, which allows companies to do more for less, reducing their need for capital; demographics again, leading to smaller working populations; and less incentive to re-invest surplus cash because income-seeking shareholders are rewarding companies that choose instead to put it towards dividends and share buybacks.
Not everyone accepts this overly technical explanation but that hardly matters. You only have to look at the chart of interest rates over the past 35 years to know that, whatever the reason, it’s simply how things are. Not even Yellen can fight this multi-decade structural shift.
What does it mean for our investments? First, it means that, whether the Fed moves in October or December, rates will stay low compared to their long-term history for an extended period. The trajectory of rate rises will be shallow and they will end up lower than in previous cycles.
Income stream with a roof on
That, in turn, means that demand for income will stay high for the foreseeable future. With more people moving into retirement in the years ahead, assets that are able to provide a steady, sustainable and, preferably, rising income will be in demand. It’s why dividend-paying shares are so highly-rated and why commercial property – an income stream with a roof on – is getting more and more expensive.
With income hard to come by, investors are likely to seek it in different places and to favour investment solutions that put those sources of yield together for them in one blended, low-volatility package. It’s why multi-asset income is the buzz phrase in asset management today.
And if you thought that the market wobble in recent months presaged a bear market, I think this world of secular stagnation will most likely provide the backdrop for the opposite. Longer-for-lower interest rates and bond yields will make equities look relatively attractive. Earnings multiples will become higher than historically, which is why stock market valuations have been flashing red for so long even as markets have risen.
In a stagnant world of low rates, income will be highly prized but so too will growth. Innovative companies with a competitive advantage – most likely to be found in intellectual-property driven sectors like technology, healthcare and media – will lead the market.
