How an interest rate rise will change the investment landscape – MoneyWeek

Thestandardexplanationforwhymoneyhasgrownsomuchcheaperoverthelasttwodecadeshasbeentheexistenceofahugeglutofsavings,mainlyfrombigeconomiessuchasChinaa

Thestandardexplanationforwhymoneyhasgrownsomuchcheaperoverthelasttwodecadeshasbeentheexistenceofahugeglutofsavings,mainlyfrombigeconomiessuchasChinaandJapan。

Butwhiletrue,thathasntbeenthewholestory。

Therehasalsobeenasteadydeclineininvestment。

InvestmentasashareofglobalGDPfellfromapeakof26%backintheearly1970s,toarecentlowofjust20%ofGDPin2002。

Ithasbouncedaroundthatrelativelylowfigureformostofthelastdecade,accordingtoMcKinseyscalculations。

Now,though,itmightbeabouttotakeoffagain。

Theworldgoesthroughoccasionalmegainvestmentbooms。

Theindustrialrevolution,forexample,orthepost-warreconstructionofEuropeandJapan。

Itmaybeonthebrinkofanotherone。

Newcountriesareindustrialisingfast,andcreatingnewcitiesatthesametime。

AcrossAsia,Africa,LatinAmericaandeasternEurope,thereisasoaringdemandfornewinfrastructure。

Roads,railways,watersystems,homesandfactoriesareallbeingbuiltatarapidpace。

Thatrequiresvastquantitiesofcapital。

Indeed,therateofglobalinvestmenthadalreadystartedtorisequitequickly。

From2002onwards,itclimbedsharply,beforebeingchokedoffbytheglobalrecession。

Astheeconomyrecoversitwillstartgrowingagain,probablybacktothepeaksseenintheearly1970s。

Ontheothersideoftheequation,globalsavingmaywellstarttofall。

Chinaisprobablynotgoingtosaveasmuchinthenextdecadeasitdidinthepast。

Typically,aseconomiesgrowmoremature,theysavelessandconsumemore。

ThereisnoreasonforthinkingthatChinawillbeanydifferent。

Thesameforceswillbeatworkinotherbigemergingeconomies,suchasIndiaandBrazil。

Atthesametime,populationsarerapidlyageing–notjustinthedevelopedworld,butinplacessuchasChinaaswell。

Typically,olderpeopledontsave。

Rather,theytendtoliveontheirpastsavings。

Additallupandtherewillbeamuchhigherdemandforcapitalandalowersupplyofit。

Youdontneedtoknowmuchabouteconomiestofigureoutthatmeanspriceswillgoup。

Butbyhowmuch?

Noonecansayforcertain。

McKinseyestimatesthat1。

5%couldbeaddedtolong-terminterestrates。

Butitcouldbemuchmore。

Forinvestors,thatisgoingtomakeahugedifferenceinseveralways。

First,thebondmarketswillgointolong-termretreat。

Althoughtheequitymarketsgetfarmoreattention,thebondmarketshavebeeninatwo-decadebullmarket。

Youdhavebeenbetteroffformostofthattimeinvestedinbondsthanshares。

Withthecostofcapitalhittingrecordlows,fixed-incomeinvestmentsjustgrewsteadilymoreattractive。

Butrisinglong-terminterestrateswillreverseallofthat。

Bondswillenterabearmarket。

Second,equitieswillbefarmoremixed。

Ontheonehand,thecostofcapitalforcompanieswillrise。

Andshareswontbenefitfrominvestorsswitchingoutoflow-yieldingbonds。

That5%dividendthatlookedsoattractivewhenaten-yearbondyielded3%wontlooksogreat。

Againstthat,costssuchaspensionfundswillbeeasiertofinance。

Equitieswilldookay,butwillhardlyshine。

Third,itwillhaveahugeimpactonthecapitalmarkets。

Thehedgefundandprivate-equityindustrieshaveboomedasinvestorshavelookedforalternativestrategiesinaworldwhererealinterestrateskeptfalling。

Butwithratesrising,plainolddepositaccountsatthebankwilllookalotmoreappealing。

Theresnotmuchpointinpayingahedge-fundmanager20%forsomeexotic,high-riskstrategywhenyoucouldbemakingaperfectlydecentreturnjustbyparkingthecashinyourlocalbuildingsociety。

Thealternative-investmentindustryfacesbeingwipedout。

Finally,itwillaffecttherestoftheeconomyprofoundly。

Thecreditboomofthelasttwodecadeswasfundamentallyaboutmoneybeingvery,verycheap。

Theyweregivingthestuffaway–almostliterallyinthecaseofsomecredit-cardcompanies。

Consumersandgovernmentssteadilyranupbiggerandbiggerdebts,oftenwithoutmuchofanideahowtheywouldeverpaythemback。

Thosedaysareover。

Governmentswillhavetobalancetheirbooks,andsowillconsumers。

Thebottomline?

Inaworldinwhichcapitalisinshortsupply,peoplewillhavetogobacktolivingwithintheirmeans,andsavingupforthingsthattheywanttobuyorinvestin。

Nowthatreallywillbeabigchange。



ThisarticlewasoriginallypublishedinMoneyWeekmagazineissuenumber517on17December2010,andwasavailableexclusivelytomagazinesubscribers。

Toreadalloursubscriber-onlyarticlesrightaway,subscribetoMoneyWeekmagazine。

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