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THE RECENT PANIC ABOUT HIGHER INTEREST RATES: WHY ARE PEOPLE SO SCARED?

THE RECENT PANIC ABOUT HIGHER INTEREST RATES: WHY ARE PEOPLE SO SCARED?

THERE IS A GOOD REASON TO BE SCARED

Higher rates on the horizon mean many things.

It is bearish for
1.  Bonds
2.  Income stocks
3.  Companies that borrow a great deal to operate their businesses (profit margins will be negatively impacted)
4.  All assets with fixed income and rising costs

It can be bullish for
1.      Common stocks of growing companies (they will get money formerly allocated to bonds)
2.      Commodities that benefit from inflationary psychology (when short term interest rates rise slower than the rate of inflation, it adds to inflationary psychology)
3.      Companies and products that benefit from higher inflation

INFLATIONARY PSYCHOLOGY IS A TRICKY THING

People often say that interest rate increases put pressure on inflationary expectations.  In our opinion, this is only true if interest rate increases are faster than inflation increases.  Currently, it is obvious that inflation is rising faster than interest rates and as we allude to above, this causes inflationary expectations to grow.

Some other implications of higher rates:
1.      Carry Trade-Some positive and some negative influences: it is positive for currencies with higher rates; it is negative for the Japanese Yen, which has very  low rates.
2.      It is bad for speculators who borrow a lot for their speculation; however it can be good for long-term, conservative investors
3.      Stock market valuations are a function of earnings growth and interest rates.  If earnings growth remains constant, higher rates mean slightly lower P/E ratios for  stocks.
4.      It is bad for private equity.  Higher rates make it harder for private equity firms to take their companies public.  Plus, tighter credit makes it harder to borrow at the  low rates which make private equity more profitable.

SUGGESTIONS

Investors should sell bonds and income stocks that have fixed yields.  Hold cash in high yielding well-managed currencies until rates peak, which may take several years.

Higher interest rates in the U.S. can strengthen the U.S. dollar in the short term; however, other countries are raising their rates too.  Therefore, so we continue to favor higher yielding currencies like the Australian dollar and British pound.


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