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Hiking can damage your wealth: rate rises bad news for investors

09 Feb 2016

Credit Suisse Global Investment Returns Yearbook 2016 published today

• New research analyses 70,000 days of financial market history and 2,400 country-years of data across 21 countries

• Rate rises typically bad news, but immediate impact is small

• During periods of rising rates, stock and bond returns were far lower than when rates were falling; the same holds for other assets like real estate, precious metals and collectibles

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The Credit Suisse Global Investment Returns Yearbook and the Credit Suisse Global Investment Returns Sourcebook are published today.

In the 2016 Yearbook, Professors Elroy Dimson and Paul Marsh and Dr Mike Staunton of London Business School examine two issues: first, the reaction of financial markets to interest-rate rises and cuts; second, the investment performance of trading strategies over interest-rate hiking and easing cycles.

Based on an analysis of the three great crises of the 1890s, 1930s and since 2008−09, Jonathan Wilmot of Credit Suisse suggests that, over the next decade, real bond returns will be close to zero with real equity returns close to 4−6% p.a.

Published by the Credit Suisse Research Institute, in collaboration with London Business School, the 2016 Yearbook and the 2016 Sourcebook report the latest long-run return data and risk premium estimates for 23 global stock and bond markets based on data since 1900.

The latest Yearbook reports on the interest-rate sensitivity of 12 financial assets (equities, bonds, risk premia, smart beta), 12 industries and 12 real assets (gold, housing, artworks). It spans 21 countries over 116 years. The authors report that virtually all assets perform worse when interest rates are rising than when they are falling.

Giles Keating, Deputy Global Chief Investment Officer at Credit Suisse, said: “The Fed’s rate hike last December was the first-ever in the professional lives of a generation of investors and traders, and however slow, the trend is now upwards, creating uncertainty and squeezing out overvaluations across the asset spectrum. The Yearbook provides an invaluable historical perspective on this, with its treasure-chest of data and analysis across 21 countries and more than a century of data.”

“Stefano Natella, Head of Global Market’s Research at Credit Suisse, said: “The aim of the Credit Suisse Investment Returns Yearbook is always to provide a unique historical lens with which to view the investment issues of the day. With a debate over the direction of the interest rate cycle being front and centre at present, the content of this year’s Yearbook is again helping frame thinking around a topic at the top of the agenda for investors.”

2016 Yearbook

The Yearbook comprises three articles, together with profiles of 23 national and three regional markets. For each of these countries and regions, it shows the inflation-adjusted returns since 1900 on stocks, bonds, cash and currencies, as well as equity and bond risk premia.

Does hiking damage your wealth?

In the first article in the 2016 Yearbook, Elroy Dimson, Paul Marsh and Mike Staunton analyse whether the market’s fixation on interest rate hikes is historically warranted by their impact on equity and bond returns.
Based on more than a century of evidence on US interest rates (85 years for the UK) it is clear that announcement-day impacts are typically small, especially for well-signalled policy moves.

Nevertheless, rate rises are on average bad news for equity and bond investors. In an analysis of annual data covering 21 countries over the period 1900–2015, the authors find that real equity and bond returns tend to be higher in the year following rate falls than in the year after rate rises.

Elroy Dimson, Chairman of the Newton Centre for Endowment Asset Management at Cambridge University and Emeritus Professor of Finance at London Business School, said: “Until late last year, no American or British investment professionals in their 20s (and only a few in their early 30s) had experienced a rise in their domestic interest rate during their working lives. Without personal  experience to draw on, it is essential to take a longer-term perspective. We hope that our historical focus will help investors to interpret interest rate changes, if and when they happen, and to construct portfolios that have resilience over the long term."

Cycling for the good of your wealth

In their second chapter, the authors compare the investment performance of trading strategies over interest-rate hiking and easing cycles.

Across a broad set of asset classes – including equities, bonds, currencies, real estate, precious metals and collectibles – the findings point to substantial differences between returns during hiking and easing cycles. 

Historically, no asset class has offered contracyclical returns in relation to interest- rate changes. Smart beta is attracting a lot of attention at present, and the study reports that the rewards from such strategies tend to shrink when interest rates are rising.

Paul Marsh, Emeritus Professor of Finance at London Business School, said: “The equity risk premium is the return on equities in excess of the return on cash. In the USA, the risk premium during periods of tightening interest rates was just 1.8% p.a, compared with 8.8% p.a. during periods when rates were falling. In the UK, the entire equity premium was earned during loosening periods, and investors would have been better off being out of the equity market while interest rates were rising.”

When bonds aren’t bonds any more

In the third chapter, Jonathan Wilmot re-examines the three great crises of capitalism, namely the 1890s, 1930s, and the period from 2008–09 to see what light they can shed on current investor concerns. As one might expect, policy regimes and policy choices really do matter during periods of major systemic stress. History suggests that the risk today of a 1937-style policy mistake is all too real, and that we should probably not expect a standard hiking cycle. During the recovery periods, moreover, systemic fragility tends to persist, meaning that bonds yields actually trend down through the first 7-10 years of recovery, before a long secular bear market begins.

Jonathan Wilmot, Managing Director of Credit Suisse, said: “Looking forward, we think zero real returns for developed market bonds and 4–6% for equities would be a good working assumption. That means real returns on a typical mixed portfolio of bonds and stocks will likely be 1–3% p.a., down from around 10% p.a. over the past seven years. That is bad news for retiring baby boomers and will pose a structural challenge for the fund management industry.”

2016 Sourcebook

Covering 26 markets, the Credit Suisse Global Investment Returns Sourcebook, also launched today, examines risk over the long run and the historical extremes of investment performance. It documents the global long-term and shorter-term rewards for equity and bond investing, and presents the detailed 116-year dataset that underpins the Yearbook.

Mike Staunton, Director of the London Share Price Database at London Business School said: “Although world equity returns since 2000 have been somewhat disappointing, over the 116 years since 1900, equities beat bonds and bills in every country. For the world as a whole, equities outperformed bills by 4.2% per year and bonds by 3.2% per year.”

The Sourcebook also investigates the impact of investment styles on portfolio performance, providing long-run evidence on size, value, income and momentum effects in stock returns.