How is ‘higher for longer’ reshaping investment strategies?

Despite optimism that inflation would swiftly retreat, the latest numbers tell a different story. So what does this mean for investors?

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Inflation is proving to be an unrelenting adversary. In major economies such as Australia, the US, and the UK, among others, price pressures refuse to fade into the background, leaving central banks little choice but to hold interest rates at elevated levels for longer than anyone had hoped. 

It’s a move that’s forcing investors to adapt in ways they haven’t necessarily expected.

Despite optimism that inflation would swiftly retreat, the latest numbers tell a different story. 

In the US, inflation stands at a sticky 3.2%, while the UK contends with a stubborn 4.6%. In Australia, recent figures peg inflation at 4.9%, adding to the growing sense that price stability remains a distant dream.

Central bankers, from the Federal Reserve to the Bank of England, have made it clear: the fight against inflation isn’t over, and they won’t back down just because markets might prefer that they did.

The implications for investors? Profound. The ‘higher for longer’ narrative is no longer an abstract theory debated at Davos – it’s the harsh reality reshaping portfolios across the globe. Those who thrive in this environment will be the ones who grasp not just the risks but the opportunities of this new era.

Fixed-income investments are one of the most obvious beneficiaries. After a prolonged drought of attractive yields, bonds are back in fashion. US Treasury yields are sitting comfortably near decade-highs, with the 10-year yield flirting with 4.8%. UK gilts and Australian government bonds tell a similar story. For years, bonds were dismissed as uninspiring – now, they’re attracting investors seeking stable returns in an uncertain climate.

Equity markets, however, are feeling the strain. Higher rates mean higher borrowing costs, which chip away at corporate profitability and put future growth in question. The tech-heavy Nasdaq, which once dazzled with meteoric gains, now finds itself under scrutiny. 

High valuations look far less appealing when the ‘risk-free rate’ (the yield on bonds) becomes a tempting alternative. Some might argue this correction is overdue, but for investors caught on the wrong side of the trade, the sting is real.

Beyond stocks and bonds, the currency markets are being shaken up. 

The US dollar has flexed its muscles, bolstered by higher interest rates. While a strong dollar can be a boon for American consumers, it’s a headache for emerging markets that rely on dollar-denominated debt. The cost of repayment is rising, creating cracks in economies that were already struggling to recover from the pandemic. Global investors are now weighing whether these markets offer enough reward to justify the heightened risk.

For those navigating this tricky terrain, the shift requires not just a change in tactics but a change in mindset. 

Fundamentals are taking centre stage. Companies with strong balance sheets, consistent cash flows, and dividends are stealing the spotlight. In equities, sectors like healthcare and consumer staples are gaining traction.

Yet, for all the talk of challenges, it’s not all doom and gloom. Persistent high rates reward patience and discipline. 

Savvy investors are finding ways to capitalise on the dislocations caused by this seismic shift. Value stocks are outperforming their growth-oriented counterparts as investors seek shelter in less volatile corners of the market. Meanwhile, opportunities in alternative assets – ranging from infrastructure to private credit – are opening up as traditional portfolios get a rethink.

The reality of ‘higher for longer’ also carries a warning: central banks are playing a long game, but markets are known for their short memories. 

Investors betting on an imminent pivot to rate cuts could find themselves on the wrong side of history. Policymakers are determined to crush inflation for good, even if it means tolerating slower growth and higher unemployment. As Bank of England Governor Andrew Bailey succinctly put it, “The last mile in the fight against inflation is often the hardest.” Investors would do well to remember that.

So, what does this all mean for the months and years ahead? It means embracing a new normal. Higher interest rates are not a passing storm; they’re the climate we’re living in. Portfolios that mainly thrived on aggressive growth won’t cut it anymore. Adaptability is key, and so is letting go of nostalgia for market conditions that appear to no longer exist. 

The financial landscape has changed, and it’s up to investors to meet the moment.

Nigel Green, is the group CEO and founder of deVere Group, an independent global financial consultancy.

Originally published as How is ‘higher for longer’ reshaping investment strategies?