Few are asking what happens if interest rates stay where they are
Author of the article: Martin Pelletier
Published Jan 16, 2023 • Last updated 2 days ago • 3 minute read
The market action over the past few months has really got me thinking about a Zen story I recently heard.
A senior monk and a junior monk are travelling together and come across a river with a strong current. As they prepare to cross, they see a beautiful woman struggling and she asks if they can assist her. But both have made a vow to never touch a woman.
Suddenly, without even a word, the older monk picks up the woman, carries her across the river, carefully places her on the other side and goes on his way. The younger monk is shocked and speechless, and doesn’t say a word to the older monk for the next few hours.
Finally, the younger monk can’t contain himself any longer and blurts out, “You do know as monks we are not permitted to touch a woman, and so how could you do what you did?” The older and wiser monk replies, “Brother, I set her down on the other side of the river three hours ago, why are you still carrying her?”
Today’s market is dominated by younger monks who have only ever known quantitative easing and loose monetary policy. It has formed their rules of engagement and overall approach to investing. But such entrenched thinking can fall apart whenever there is a river with a strong current to be crossed.
It is natural human behaviour to look at what was successful in the recent past and think it will work once again whenever a new challenge is faced. But this leaves us open to failure if a structural shift happens and, although they may be infrequent, they do occur.
As a result, too many of us go back to carrying our old habits and patterns when we should be adapting to the situation, helping ourselves as well as others, and then moving on instead of looking back.
The pervasive theme today is that inflation and interest rates will return to pre-2020 levels. You can see this in the daily market action, with investors aggressively watching for any hints that the United States Federal Reserve will reduce its current course of action. How dare they carry her across the river, don’t they know the rules?
That said, few are asking what happens if interest rates stay where they are due to the tightness of the labour market, and, if so, where growth is going to come from. Besides, do you really want a rate cut? Just imagine the macro environment required to drive one.
We think value investing is now the old monk while growth is the young monk. Value has disappointed for the greater part of the past decade because capital was inexpensive and flowed towards high-growth business models that engaged a loss-leader approach.
Goods and services were offered at or below cost in order to rapidly build out an ecosystem and only afterwards find a way to generate a profit. In some cases, profit was even irrelevant. This approach no longer works with interest rates at four to five per cent.
To change metaphors, it helps to remember that the young hare often crashes before the finish line and the older tortoise chugs along to win the race.
This is when good old-fashioned segments of the market, such as the consumer discretionary, industrials, financials and energy sectors, will keep chugging along and even shine. There may even be value in the technology space because there are still some companies that can grow cash flow even with the higher cost of capital.
Why not use today’s volatility as a lesson to stop carrying the past and start fresh in the present moment? Old monks and tortoises may not be exciting, but they sure know how to get to the other side.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
Source: Financial Post