Higher Interest Rates: The Good, the Bad, and the Ugly.

November has been quite a month in world markets; important political news was accompanied by one of the largest moves in interest rates in market history. As discussed in the last article published November 7, 2016, we will be exploring solutions for investors during this potential transition into a higher interest rate environment. What will higher interest rates mean for investments including stocks, bonds, real estate and commodities?  

The “Good”

The major challenge for retirees and pensions in the last decade has been very low returns on what are considered lower risk investments. 15 years ago, a 5 Year GIC yielded approximately 5.00% which was a reasonable return in a government guaranteed investment. Unfortunately, that kind of return has been unavailable in lower risk investments for many years. The last couple of months have seen some changes in rates and this could be the beginning of a move towards better times for savers and retirees looking for less volatility and a stable return. The potential is that the yields on GICs may be substantially higher in the coming years but it will take some time.

The “Bad”

The potential for higher yields in coming years may be welcome news but what do higher interest rates mean for the returns on existing investments?

It really all depends on how they are structured. The focus might be on portfolios structured around lower duration ladders of GICs and investment grade corporate bonds. One might avoid investing in pools, funds, and ETFs with longer durations and/or no individual maturity dates.  Many investors will be currently positioned in structures that potentially face the full risk of higher interest rates and they might want to explore simpler investment structures. There will be more information on this in coming articles and the italicized section above will be explained in detail.

Higher yields on lower risk investments such as GICs in the future may also result in the market selling certain equity investments that were purchased only because reasonable returns were not available on guaranteed investments. We have already witnessed some of this selling and rebalancing in the past few weeks and the trend may be changing for certain sectors of the market. The focus of equity investments should continue to be on quality and balance with the inclusion of inflation hedges.

The “Ugly”    

Interest costs on debt may rise substantially in coming years causing financial stress on governments, corporations, and individuals that have borrowed too much during this period of lower rates. This will add costs for governments that will probably be passed on to taxpayers on civic, provincial/state, and national levels. Companies with large debt levels may face higher interest costs as their debt maturities are rolled over. Individuals with large residential mortgages may face very difficult times as they refinance at potentially higher and higher levels. Interestingly, The Canadian Mortgage and Housing Corporation (CMHC) recently released a stress report on Canadian housing that concluded that there may be more risk to housing prices from higher interest rates than if there was a global depression. This would seeem to mean that there is as much or more risk from a good economy than there would be from a bad economy: interesting times.

The focus on coming articles will be on real practical solutions for investors.