Higher Interest Rates, a Looming Recession and High Uncertainty
During the second quarter of 2022 asset prices contracted through persistent uncertainty concerning inflation, economic growth and political unrest.
On June 15th, 2022 the US Federal Reserve increased the interest rate charged on federal funds by 0.75% which is the largest single increase since 1994 (Source: CNBC). Interest rate hikes are expected for the next nine meetings till July 2023 (Source: CME Group). The Bank of Canada will likely follow a similar path over the next year. These interest rate increases will continue until central banks are confident that inflation is under control. What this means for borrowers is that they can reasonably expect rates on 5-year fixed mortgage to be greater than 6% at this time next year.
There are risks to our economy as these aggressive rate hikes could tip us into a recession – but slow rate hikes may allow inflation to remain. At a time like this we might be inclined to take our money and retreat to a safe place while things get sorted out. That would be a mistake and this is why it’s so important we lean on our investment discipline to guide our asset allocation decisions. This principle applies to both our behaviour and the investment approach applied by our investment partners. When we combine the discipline of these two the results are pleasing.
What helps us sleep at night
This is a question that people ask more frequently during down markets. EdgePoint Wealth recently published an article that explains in detail their investment approach and how it applies to specific investments and opportunities in their portfolios. We believe this is a worthwhile read for investors – and especially those who invest in their portfolios.
The Psychology of Money
Our team recently attended a presentation by Morgan Housel who is an author and former journalist at the Wall Street Journal. Morgan shared some of the lessons from his recent book entitled “The Psychology of Money” and I thought I would share two of them with you here:
Lesson #1: Timing is meaningless, time is everything. When Morgan published his book in 2020, Warren Buffett’s net worth was $84.5 billion. Of that, $84.2 billion (or 99.6%) was accumulated after his 50th birthday. Although Buffett has enjoyed strong investment returns over the course of his life, it has been the time he has been investing that has had the greatest impact on the compounding of his wealth. If, for example, he had begun investing at age 30 (rather than 10) and stopped investing at age 60, his investing time horizon would have only been 30 years and his net worth would have been $11.9 million. This is a powerful lesson that investing is not about each year’s individual investment returns, instead it is about having an investment plan that you can stick with and that can be repeated over a long period of time – ideally over a lifetime
Lesson #2: You can plan for every risk except for those that are too crazy to cross your mind. These “crazy” events happen more than we think and avoiding them is impossible as they cannot be anticipated. It is, therefore, important to create redundancy in our financial plans. Housel referenced suspension bridges which are built to stand even with missing cables. In the same way that a suspension bridge does not rely on a single cable, your financial life should not rely on a single investment. We incorporate different holdings and different asset classes in financial plans (equities, bonds and cash) for this very reason. These alternatives provide safety not only for risks we anticipate but also for those we cannot. The cash and low-volatility assets can be accessed when disaster strikes or deployed into the market when opportunity arises.