When describing his outlook for interest rates, Tyler Mordy likes to use the words often attributed to John Maynard Keynes after he was criticized for changing his position on monetary policy during the Great Depression: “When the facts change, I change my mind. What do you do, sir?” Keynes is said to have uttered.
Mordy, who is Forstrong Global’s President and CIO, was a supporter of the “lower for longer” viewpoint following the financial crisis, but that changed in the summer of 2016. There was no overnight change in market conditions, but gradually the reality of an ongoing deflationary backdrop fell away and the prospect of lower interest rates for a sustained period seemed less favourable.
The conditions have been evolving gradually since before the summer of 2016, but, unlike Keynes, many investors are not prepared to change their stance even if the ‘facts’ of the market have changed.
“In the same way that investors took more than a decade after 1980 to believe that inflation would not rise again into double digit figures, today’s investors — conditioned by at least 35 years of disinflation and declining interest rates — will take years to become convinced that the secular environment has changed,” Mordy says. “Bond rallies will still present themselves, however, for Western bond market exposures, keep duration strategically short and tactically take on floating exposures (FLRN) when bonds become overbought.”
Mordy also urges investors to recognize that many assets were bid up on the “lower forever” thesis, which includes a variety of interest rate sensitive investments in the West, such as REITs, dividend payers and the influx of new ETFs that produced a higher and more tantalizing yield.
“To be sure, our clients relished in this yield bonanza (with our Global Income Focus producing double digit annualized returns since its June 2008 inception), but no party lasts forever and we are now shifting strategy in income-oriented mandates,” Mordy says.
“Finally, bear in mind, that we expect a gradual reversal in yields that will play out over many years. And while a spike in rates is clearly detrimental to fixed income investors, a slow and steady rise allows for a higher reinvestment rate without incurring large capital losses. This is wonderful news for retirees who have had considerable difficulty generating sufficient income in an abnormally low interest rate environment.”