Investment: Sensing changes ahead in balance of risks - Business - News - The Independent

Investment: Sensing changes ahead in balance of risks

THE HARDEST thing of all to do in financial markets is to call a turn in the key economic indicators, such as inflation or interest rates. You have to be either a mug or a masochist if you think that you can get them right with any degree of precision, which is why most of those who make those calls only do so when they are being paid a lot of money to stick their neck and risk getting egg all over their face.

The best technique, one of those well-paid market mavens once told me, is to "forecast long and forecast often". That way, with any luck, if you are wrong, nobody will be able to remember just how wrong you were. And if by any lucky chance you prove to be right, you have a choice of baselines from which to demonstrate how good your forecasting has been. Does that sound too cynical? I hope not. It is meant to be a realistic assessment of the state of the forecasting business. The truth is that it is rarely difficult to identify which variable is the key parameter in the market outlook at any one time. What takes time and good fortune is to identify in which direction that parameter is likely to go next. In most cases, experience suggests, the simplest and safest method is to assume that the current trend, whatever it is, will continue into the near future.

Thus, for example, at almost any point in the 1990s, anyone who assumed that the level of inflation and interest rates would continue to fall would have discovered a very workable investment strategy. The reality is that the downward trend in both variables has been the single most outstanding feature of the investment climate in the decade. On the time- honoured basis that for investors the trend is your friend, it would be unwise to assume that this trend will reverse until or unless there is some clear evidence that it has run its natural course.

But there is little doubt that we have now reached a genuine decision point as far as global interest rates are concerned. Even those of us who have successfully championed the buying of bonds as an asset class in the 1990s are now forced to contemplate whether or not that game has finally had its day. I am not referring to the next movement in short- term interest rates, which remains a largely parochial issue, but to the far more important movement in long-term interest rates, as reflected in the yield on long maturity bonds.

The question of whether long-bond yields have bottomed out has been asked at repeated intervals throughout the decade. There were those who thought that the bottom had been reached in 1994, when a surprise move by the Federal Reserve to tighten policy left many professional investors nursing hefty losses on their bond holdings. In fact, viewed from the comfort of today's perspective, it proved to be a mere blip on the historical interest rate charts. According to Barclays Capital, the data shows that global interest rates, as measured by bond yields, have fallen steadily to new lows in 1998. Any satisfaction that the UK might have taken from the fact that interest rates have fallen so sharply in the last decade is tempered by the realisation that in real terms, we suffer from some of the most lowly rated government bonds of any country in the world (Greece and Italy included).

The significance of falling long- term interest rates lies in a simple mathematical formula. Whether you are talking about the value of a stock market as a whole, as market strategists like to do, or about a particular company's shares, the value of any financial asset can be found by a simple equation, of the form x = y/z.

The top line in the equation (the `y') is the expected future stream of profits or dividends that you expect to accrue to the investor. The bottom line (the `z') is a rate of interest that represents the long- term opportunity cost of investing in that future stream of income. Divide one by the other and in principle you have the intrinsic value of the investment you are thinking of making - a benchmark against which you can compare the current price at which you are being asked to invest. In practice, of course, this simple sounding formula is impossible of precise evaluation: if everyone knew for certain what a market's future earnings were going to be, and/or the level of interest rates which would prevail over say the next 10 years, there would be no need to have financial markets at all.

What has happened, in very broad terms, over the last 15 years of bull market conditions is that both the top and bottom lines of the market valuation equation have risen together. Company profits and dividends have risen (from an initial very low base in the 1970s) while interest rates have also fallen steadily from their very high levels at the start of the 1980s. The question now is whether that long and beneficial secular trend has come to an end.

The Federal Reserve has this week given us a clear signal that its policy of accommodating the stock market boom in order to secure wider economic goals (such as the stability of the financial system) is nearing the end of its course. The long bond yield in the US is now well above its low point of last year, and the trend looks set to be followed elsewhere in the world.

Only a fool, or a Midas, as I said at the outset, would want to give a definitive call about whether the interest rate decline is over for all time. But my sense is that the balance of risks in most countries is now against the trend of the past 15 years continuing for much longer. It will be great if it does, but the prudent investor, I suggest, will be starting to prepare strategies for countering the alternative outcome.

John Travolta is a qualified airline captain and employed the pilot with his company, Alto
people'That was the lowest I’d ever felt'
Life and Style
healthIt isn’t greasy. It doesn’t smell. And moreover, it costs nothing
peopleThe report and photo dedicated to the actress’s decolletage has, unsurprisingly, provoked anger
Home body: Badger stays safe indoors
The programme sees four specialists creating what they believe are three perfect couples, based on scientific matchmaking. The couples will not meet until they walk down the aisle together
tvUK wedding show jilted
Arts and Entertainment
US pop diva Jennifer Lopez sang “Happy Birthday” to Gurbanguly Berdimuhamedow, president of Turkmenistan
musicCorporate gigs become key source of musicians' income
Arts and Entertainment
You've been framed: Henri Matisse's colourful cut-outs at Tate Modern
artWhat makes a smash-hit art show
ebooksAn unforgettable anthology of contemporary reportage
Arts and Entertainment
While many films were released, few managed to match the success of James Bond blockbuster 'Skyfall'
filmsDaniel Craig believed to be donning skis as 007 for first time
Mikel Arteta pictured during Borussia Dortmund vs Arsenal
champions league
Yes supporters gather outside the Usher Hall, which is hosting a Night for Scotland in Edinburgh
voicesBen Judah: Is there a third option for England and Scotland that keeps everyone happy?
Arts and Entertainment
Pulp-fiction lover: Jarvis Cocker
booksJarvis Cocker on Richard Brautigan
Arts and Entertainment
Robin Thicke and Pharell Williams in the video of the song, which has been accused of justifying rape
music...and he had 'almost no part' in writing it
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Sales Executive

£20 - 24k (Uncapped Commission - £35k Year 1 OTE): Guru Careers: We are seekin...

Payroll & Accounts Assistant

£20 - 24k + Benefits: Guru Careers: This is a great opportunity for an enthusi...

SQL Developer - Watford/NW London - £280 - £320 p/d - 6 months

£280 - £320 per day: Ashdown Group: The Ashdown Group have been engaged by a l...

Senior BA - Insurance **URGENT**

£400 - £450 Per Day: Clearwater People Solutions Ltd: **URGENT CONTRACT ROLE**...

Day In a Page

Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam
'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

'She was a singer, a superstar, an addict, but to me, her mother, she is simply Amy'

Exclusive extract from Janis Winehouse's poignant new memoir
Is this the role to win Cumberbatch an Oscar?

Is this the role to win Cumberbatch an Oscar?

The Imitation Game, film review
England and Roy Hodgson take a joint step towards redemption in Basel

England and Hodgson take a joint step towards redemption

Welbeck double puts England on the road to Euro 2016
Relatives fight over Vivian Maier’s rare photos

Relatives fight over Vivian Maier’s rare photos

Pictures removed from public view as courts decide ownership
‘Fashion has to be fun. It’s a big business, not a cure for cancer’

‘Fashion has to be fun. It’s a big business, not a cure for cancer’

Donatella Versace at New York Fashion Week