Interest rates are rising and it will affect every asset class

Here’s what every investor needs to know in face of looming interest rate increases.

Everyone — not just income-seeking investors — needs to promptly reassess the investment market.

Is it a turning point? RBA governor Philip Lowe could not be more direct — “prepare for higher rates” he said this week — but how exactly might investors do that?

We all know interest rates are moving higher around the world but Lowe’s comment capped a week which might just turn out to be a milestone.

Only days earlier NAB, which until recently suggested we would have no change in rates until 2019, reworked its numbers. Suddenly the bank changed its tune: there will be two rate rises next year, it suggests.

Other banks are not waiting for the RBA to move. At HSBC, where chief economist Paul Bloxham says the RBA will lift rates no later than March next year, the global bank is offering cash deposit rates of 3 per cent.

Why you might ask is a commercial bank offering deposit rates that are twice as high as official rates (still unchanged at 1.5 per cent). Because the wind is changing direction and investors need to sit up and notice.

It’s hard to believe but Australian investors have not had to consider the implications for investing in a market where rates are rising since 2011. In other words, the so-called “hunt for yield” — better described as the hunt for non-cash yield — is coming to an end.

Just to put some figures on it, back in 2011 Australian investors, typified by SMSFs, had 20 per cent of their entire investment portfolios in cash; today that figure has dropped to 15 per cent.

Moreover, it was not that investors — especially older and more conservative investors — ever wanted to withdraw cash and place it in the riskier world of shares or property. They had little choice with rock-bottom rates which were often lower than inflation.

Now all that is about to change, and it may change a lot faster than anyone in the market, including HSBC, is forecasting.

What does it mean for the private investor? Put simply, it means a switch in focus from income to growth. But markets are rarely so easy to read. The reality is likely to be a lot more complex. Here’s what you need to know for each asset class.

Cash

No other asset class has been so out of fashion since 2011 than cash but investors will now be looking at cash deposits once more. The risk-free nature of cash — especially the explicit guarantee from the government on cash holdings — means that from a security perspective this asset class is unbeatable.

With deposit rates inching higher all over the world — and early signs they are moving in our own market — cash deposits are set to return from their denuded role as a “store of value” to becoming a genuine investment choice once more.

Income stocks

It is hard to exaggerate the significance of what has happened to Telstra since the telco announced in August it was cutting its dividend: the stock has simply fallen in a hole. From a price of about $4.30 at the time CEO Andy Penn delivered the news to a stunned legion of shareholders, Telstra is now trading at $3.60. Not every “income stock” may suffer the same fate — bank stocks, for example, may profitably exploit rising rates — but for companies that have put income at the top of the agenda above all else, the writing is on the wall.

A-REITs

Property trusts — more commonly known as A-REITs — have already been suffering as the first wave of yield sceptics withdrew from the market.

With looming rate hikes, property trusts were always going to be in the firing line. They are down 6 per cent against a broadly flat ASX 200 this year. But there could be much more testing times ahead because they are leveraged at a time when rates are rising and prices are set to flatten.

Gearing rates above 40 per cent signalled real trouble the last time the cycle went against property trusts and there are several testing this level in late 2017: Cromwell and Centuria both have gearing rates above 40 per cent, Westfield is at 37.5 per cent. Crucially, these rates have not yet raised eyebrows because the trusts have been coasting on rising valuations.

WEB Wealth Property trust rates

Property

In common with bank stocks, which some will say are a proxy for the residential property market on the ASX, the outlook for direct property is much more difficult to call. House prices are already flattening and there is little doubt the “mortgage stress” barometer will be tested further if rates rise again.

Nonetheless we have already seen investor mortgage rates creep up above 5 per cent without any compelling evidence it is forcing house prices lower. More likely a string of negatives — including gradually increasing mortgage rates — will combine to cool house price growth in selected locations but not everywhere. For investors, if you have not fixed at previously low levels, the servicing of mortgages is almost certainly going to get more difficult.

Bonds

The Australian retail market has little direct exposure to bonds; rather, most investors have exposure through institutional super funds or balanced managed funds. Either way, a long anticipated surge in fixed bond yields with a parallel drop in bond prices is in the offing and the end results will be negative total returns in many cases. Bond yields are already up in the US, and the Australian government 10-year yield is now testing 3 per cent (2.8 per cent), the highest since 2014.

The key conclusion is that the hunt for yield is over. Everyone — not just income-seeking investors — needs to promptly reassess the investment market.