The supposed benefit, or consequence, of central banks holding interest rates at ultra-low levels since the GFC, and at levels below normalised GDP, has been soaring prices for risky and real assets.

But investors cannot have it both ways; as the US Federal Reserve reverses its highly accommodative monetary stance, the consequence must also be a reversal of those soaring asset prices.

And make no mistake, this process has already begun; however, this time, it is property investors who seem to be experiencing the effects of falling over the precipice, and equity investors have yet to catch on.

We have been tracking US 10-year Treasuries since they hit 1.36 per cent in 2016. Why? Because that was the lowest rate since Captain Cook crossed the Arctic Circle in 1778. And as economist Herb Stein observed, if something cannot go on forever, it must stop. Recently, US 10-year rates hit 3.2 per cent. More about that in a moment.

For more than two decades, I have carried with me an aphorism, and while I cannot recall to whom it should be attributed, I have never forgotten how useful it inevitably and frequently is. The aphorism is this: “Rising interest rates are not a problem until they are.”

Initially, rising interest rates are sign of a strengthening economy but at some point, they become a noose around growth’s neck, strangling it along with asset values. Sentiment simply, and unpredictably, turns. Investors who were once enthused about the prospects for growth start worrying that the effect of higher rates on asset values will affect asset prices.

That inflection point in sentiment might have just occurred.

In the first two weeks of October, the global sell-off in bonds, and the associated rise in bond rates, leaked into equity markets.

On the back of that stronger US economy, real yields are now rising, too; while US 10-year Treasury rates have risen to a seven-year high of 3.25 per cent, the real yield (adjusted for inflation) is now above 1 per cent for the first time since 2011. As the effects on real yields from an end to accommodative monetary policy begin to be felt, the impact will be meaningful.

As rates rise, particularly real rates, the cost of capital and risk premiums increase across the economy, affecting all asset values and the attractiveness of investments and projects.

The worst effects from higher real rates are reserved for long-duration assets – those ‘growth’ investments with future-dated cash flows. Think about those profitless companies like Xero and Afterpay, whose shares have rallied amid a chase for business and share price momentum.

Afterpay, from its opening price this calendar year of $6.00 a share, rallied to more than $21 by the end of August, as the company signed up hundreds of merchants, hundreds of thousands of customers and rolled its offer out to the US and the UK. But in just the subsequent six weeks, Afterpay has fallen by more than a third.

Afterpay still makes no profit and trades on a market capitalisation of $3.2 billion, which is 44 times 2020 net profit after tax. And that 44 times earnings multiple is only on the basis that NPAT increases by more than 300 per cent that year.

Investors in small-capitalisation stocks, and stocks in loss-making ‘growth’ companies, should approach the markets with a healthy dose of caution. Much more so than in recent years. At Montgomery, we have been making portfolio adjustments over the last nine months. As investments were sold, the cash was not immediately recycled; with everything rallying hard, finding value was almost impossible anyway. Instead, the cash was parked awaiting opportunities in larger companies with stocks displaying much lower beta.