Even if inflation does not change, real interest rates are “very likely” to rise over the next months and year, Rothschild Wealth Management’s global investment strategist, Kevin Gardiner, has said.
According to Rothschild’s September 2017 market perspective: ‘Ten years gone | Aggressive passive?’, despite the expected rise in interest rates, “a dramatic acceleration in costs and prices, and a more sudden normalisation of policy and of bond yields, feels even less likely than it did”. Mr Gardiner added that “low inflation does not seem to have hurt profitability or employment”.
Mr Gardiner noted that concerns about the market can be grouped into three headings: investor sentiment; valuations; and echoes from the global financial crisis (GFC) as its tenth anniversary approaches. He said of investor sentiment that the central banks “have remained in firefighting mode, and this very public commitment can itself be seen as a form of free portfolio insurance, mitigating the need to pay for it directly”. He added that low interest rates may have encouraged “yield-seeking investors themselves to sell insurance”.
In terms of valuations, while concern over valuations have grown as stock prices have risen, corporate profits “have recently been rebounding” and though valuations are higher than usual, they are not ‘prohibitive’. “Relative to money and bond markets, equity markets do look cheap,” Mr Gardiner continued. “But we should not rely on these comparisons: we expect interest rates and bond yields to rise gradually from their historic lows.”
The European Central Bank’s ongoing purchases is ‘boosting’ investment grade credit, like the government bond market, and yields “would be lower still were it not for recent issuance” Mr Gardiner said. “Speculative grade credit may be most fully valued: in Europe, yields have dipped to match those on stocks for the first time.”
Mr Gardiner stated that markets are “being scrutinised for signs of history repeating of rhyming” with regard to the global financial crisis anniversary. He highlighted negative government bond yields and money rates and tight credit spreads amidst surging corporate bond issuance among recent “eye catching developments”.
However, he reinforced that most assets “seem to be either fully valued or expensive, just as the interest rate cycle is slowly turning a corner”. He added: “Banks are less geared than in 2007, and fewer expensive and complicated investments are owned with borrowed money. Banks are also less dependent on wholesale deposits, and interbank spreads are docile. Housing loan-to-value ratios are lower.”
Mr Gardiner concluded that stocks remain Rothschild’s preferred asset, and remain “the most likely asset to deliver inflation-beating returns”. Bonds and cash are being viewed by Rothschild as portfolio insurance, as the preferred high-quality corporate bonds are “unlikely to deliver positive real returns”.
Rothschild favours relatively low-duration bonds in Europe, and views “some attraction” in inflation-indexed bonds in US dollar portfolios. Meanwhile, Rothschild’s ‘top-down’ regional conviction on stocks remains low, and the firm prefers “a mix of cyclical and secular growth to more defensive bond-like sectors – a preference that has, if anything, strengthened slightly in the last month”.
Rothschild Wealth Management’s clients include families and entepreneurs. The company is part of Rothschild & Co, a global and family-controlled group, providing investment and wealth management solutions to large institutions, families, individuals and governments.