Investment Outlook: How to think about the increase in Interest Rates
Updated: Apr 2, 2022
Layth Matthews discusses the outlook for financial assets and interest rates in the face of rising oil prices and the war in Ukraine.
Mark Whaley (MW):
Welcome to the Rigden Financial YouTube channel. My name is Mark Whaley and today is March 18th, 2022. I'll be asking Layth Matthews, President and Lead Planner at Rigden Financial about investments, interest rates, and other helpful topics to assist in your financial planning. Today I wanted to ask you about your thoughts on the current investment environment, but particularly about the recent federal reserve rate hike - the first one since 2020 I think - can you tell us your thoughts on what's happening and how investors could think about it.
Layth Matthews (LM):
Yeah sure - The Bank of Canada recently raised the bank rate, which is the rate at which
it lends to Canadian banks, by a quarter of one percent and the news this week was that the Federal Reserve raised its rate by a quarter-point. I think it was the first time since 2020. It's widely regarded as being the beginning of what they call a tightening cycle. The bank of Canada was really moving in advance just because of the timing of their meetings but basically, both central banks and maybe central banks all over the world are starting to raise rates a little bit and the reason for that is that the economy is coming out of the danger of recession from the covid pandemic. There's just a general, I would say more than an uptick, there’s a trend in inflation and there's a general sense that house prices and some asset prices have become overinflated because of low interest rates. That is because there's the leverage that goes into these things and so this has been anticipated and interestingly the stock market response was to go up! Usually, people regard higher interest rates as threatening to the stock market, but what you have to remember is that the stock market anticipates everything and so a lot of times when the situation comes to pass that has been anticipated. There’s a kind of a relief rally you could call it - because the federal reserve sometimes will raise rates more aggressively - more than a quarter of one point. Maybe they might raise interest rates half of one percent in one go and that gives an indication to the marketplace of how worried they are about inflation and the likelihood of the need for many more interest rate hikes.
Interesting, so how does that relate to what else is going on in the world with oil prices and what's happening in Ukraine - is there a correlation there?
Yeah, I think there is. The war in Ukraine - the uncertainty that has caused the interruption of fuel transfers from Russia - Russia only accounts for about 10% of the oil supply for the world, but just the threat of interruption there has created a real spike in oil prices. You can't really see it from this chart but you can get some sense of it. I'll show you a chart now of the TSE versus the oil price or one oil price.
So this is a chart of West Texas Intermediate crude. It’s a typical index of oil that's used and what it's showing us is that the price of oil has gone up in the last year from 75 it got up to 125. Of course, it’s come down drastically because there are many reserves and other sources of supply for oil but definitely in a world with much higher oil prices, and oil goes into so many things - gasoline and petrochemical products - a rise in oil prices can create the same effect as a raise a rise in interest rates.
Gotcha yeah so the whole world is basically reacting to what's going on right now, including the federal reserve it seems.
Yeah, so what it does is a rise in oil prices takes the pressure off the central banks - the Bank of Canada and the Federal Reserve Bank to raise interest rates so aggressively because the rise in oil prices is kind of doing some of the work for them. The stock market on the other hand is kind of having a relief rally because the threat of aggressive rate hikes is mitigated now because oil prices have already gone up. You know there may be some sense that the inflation that we have is temporary. We're not looking at a wild consumer boom, it may be a more gradual one and so the need for higher interest rates which kind of threatens stock market values is going down.
You mentioned a staircase does that mean that interest rates are going to continue to rise in the near future or is that more of a long-term thing?
Well, the expectation is that every six weeks or so when these central banks meet they will actually be raising interest rates by a quarter-point and there's some speculation that maybe within a year or so that they will have raised rates six times. So if they do a quarter-point rise every time, interest rates can likely and will likely rise by one and a half percent. So if you're in a variable rate mortgage and you know your mortgage right now could be anywhere around somewhere around two percent that means that it could potentially go up to three and a half percent which is just a little bit north of where the five-year fixed mortgage rates are right now. But these things are done gradually and historically stock investments have actually performed fairly well in a rate tightening cycle. But you know there's too much uncertainty about this conflict in Ukraine. There’s nothing really you could say about it that wouldn't be speculative. I feel like the humanitarian cost of it is awful. There’s a lot of good reasons why - well I can see from one side I understand the west side better than I understand the Russian side that's for sure but you know I think ultimately it's an ideological battle and ideological battles tend to cause a lot of real casualties which is unfortunate. I don’t see how Russia can withdraw and save face because so much of their policy has been about strengthening the impression of them as a superpower. If they get a humiliating defeat it's poisonous for the image that they have constructed and maintained very carefully for a long time. I'm a little bit concerned that we're not basically giving them a diplomatic way to save face and withdraw because I don't think they're going to be able to accept an outright defeat. We could have a prolonged area of conflict there.
Well even in this uncertain time it seems the best advice is maybe to just
keep your eye on things.
Or keep your eye off things. I posted on the Rigden Financial Facebook page an article that came out today. Another research report basically said if you follow the 24-hour news cycle it's probably bad for your investment decisions. This chart represents the comparison of two investors. One who stayed invested in the stock market all the way through all the ups and downs and crises and wars etc - market crashes over the years. That's the red line and the blue line represents an investor who sold out of the stock market at the peaks and then waited and stayed in cash and then bought back in when the market was starting to go up again so you can see from the results here that basically if you invested a dollar you would have been, overall this period of time, you would not have made a significant difference to get in and out of the stock market in that particular way. So I mean you know if you think you could call the market accurately and you know that would be called the market timing and really, some of the great Nobel prize winners of our time, have lost fortunes trying to do that (laughter). So it comes back to my comments from last week, which is that you know what you really need to do is identify an asset allocation strategy that is suitable to your needs and goals and risk tolerance and then pretty much stick with it.
Yeah just stick with it during good times and bad.
Yeah I mean it means dutifully allocating money to cash and bonds or you know fixed income type investments and those can be pretty boring or unattractive in the short run but you can compromise by buying stocks that have high dividend payouts and that's kind of like a half step in between fixed income and you know still buying productive assets as Warren Buffett recommends. There's no safe haven because even in a world of conflict the government policies are going to be funding whatever it is they're going to be doing to mitigate the interruptions to the economy. So it makes cash fiat currencies which are basically dependent on government restraint for their value. It makes them less trustworthy, then you get inflation in those types of situations. Owning productive assets does protect you in a certain way.
Great, well thank you so much for that. It's really helpful.