Rethinking the New Normal for Interest Rates and Fixed Income Investing
Everyone loves a fairy tale and so allow me to begin this commentary by telling you a story:
Once upon a time, there was a little investor named Goldilocks. Goldilocks went for a walk in the investment forest and pretty soon she came upon a house. When she knocked at the door, no one answered, but the door was slightly ajar and so she walked right in.
At the table in the kitchen, there were three bowls of porridge. Goldilocks was hungry and so she tasted the porridge from the first bowl. “This porridge is too hot!” she exclaimed. So she tested the porridge from the second bowl. “This porridge is too cold,” she said. So she tasted the last bowl of porridge. “Ah, this porridge is just right,” she said happily and she ate it all up.
After she had eaten, she grew a little tired. She walked into the living room and found three chairs. Goldilocks sat in the first chair to rest her tired feet. “This chair is too big!” she exclaimed. So she sat in the second chair. “This chair is too soft,” she cried. So she tried the last and smallest chair. “Ahh, this chair is just right”. She sat for a while but found she was too tired to simply sit down.
So Goldilocks went upstairs to the bedroom. She lay down in the first bed, but it was too hard. Then she lay down in the second bed, but it was too soft. Then she lay down in the third bed and it was just right! And Goldilocks fell asleep.
Of course, this story is the beloved fairy tale of Goldilocks and the three bears. The story was first told in 1837 and told the story of an old woman who trespasses on the three bears’ property. Since then, there have been many revisions to the story until the story familiar to us included a young girl and three bears including a papa, mama and baby bear.
By now, you must be wondering where on earth I am going with this storytelling. For many months we have been telling our clients (and everyone else who listens to us), that we believe interest rates are heading higher. Our advice has been to lower and limit fixed income holdings particularly in bond markets, to lock into longer term fixed rate mortgages, and to focus primarily on dividend paying local and global growth investment stories. So why re-tell the fairy tale? We somehow seem to be sounding like a broken record, and the story has become all too familiar. And yet, like a fairy tale, sometimes in the retelling we hear something new and the familiar provides new insight.
Often when we read the volumes of market commentaries, outlooks and forecasts, certain words and terms are seen over and over again. One term that I have recently seen on a frequent basis is ‘Goldilocks Economy.” What does this mean? According to investopedia.com, the Goldilocks economy is an economy that is not too hot or cold, but rather sustains moderate economic growth, and that has low inflation which allows a market friendly monetary policy. The first time this fairy tale was related to the investment markets was in 1992 by David Shulman of Saloman Brothers who wrote an article “The Goldilocks Economy: Keeping the Bears at Bay”.
How does this relate to your investments and portfolio?
- Like porridge, we feed on growth. Growth is the energy that propels markets forward,
- Like on chairs, we “sit” on interest. Interest is good but in this market, does not get us anywhere,
- Like a bed, dividends allow us to “rest” while waiting for the energy that comes from growth.
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