Goodbye to the Financial Upside Down?

Have you binge-watched Stranger Things yet? It’s a Netflix show that mixes sci-fi and horror – it centres around a frightening paranormal world called the “Upside Down.”

The Upside Down mirrors our world – except that it’s quite dusty, always dark, and full of monsters. Worse – we’re not quite sure where it came from or how it ends – we just know it’s bad…

The Upside Down also looks a lot like the financial markets that investment managers have been navigating since 2008, the year when the financial crisis took the world as we know it to the brink of disaster.

Since that time, it’s felt like markets are filled with uncertainty and new risks – and that long-standing norms of investing have been turned… upside down!

For one thing, money has never before been this cheap. And interest rates have been so low that decades and decades of advice about saving and spending money have gone out the window. Whereas long-term savers could once keep their money safe in bank or in long-term bonds, today’s low rates mean you’re taking a big risk that your savings won’t keep pace with inflation.

The bond world has also been sucked into the Upside Down of financial markets:  years of falling interest rates, have pushed yields (the return paid to bond holders) to all-time lows.  In some cases, governments and corporations are borrowing money at negative rates of interest,   creating so-called “negative yields.” That means some lenders are actually paying borrowers to take their money!

And if that’s not upside down enough, there are trillions of dollars in negative yield bonds trading right now – literally thousands of investors paying borrowers to take their money.

While this runs counter to our best instincts about saving and lending, it actually makes some sense in today’s financial markets upside down.

Low yields are a product of post-2008 monetary stimulus — as governments in Europe and North America fought to keep the financial system from melting down, they pushed down interest rates to make it easier for companies and individuals to get and spend money. The idea was that money would flow back into the economy and get it growing again through spending, hiring, and new production.

Because interest rates are so low and some institutional investors have to invest in safe assets to meet certain capital requirements, it can make sense for them to hold negative-yielding debt instead of parking their money in cash.

The end of upside down?

The good news is that rates are starting to rise in both the U.S. and Canada…something we are much more used to.

The question is, will that make things normal again? Or simply take us to a new level of upside-down-ness?

No one is certain but rising interest rates will push bond prices down – and although yields will go up, it could put an end to a decades-long bond bull market that has seen prices tick up every year. Remember: bond prices move inversely to interest rates – the higher the yield, the lower the price.

For us, at Bridgeport, that means staying the course:  holding bonds with shorter maturities so we can avoid risking loss as bond prices fall.  It also means avoiding significant exposure to government bonds, where low interest rates and negative yields have really taken a toll.

Can we kiss the Upside Down goodbye? Clearly not yet – but we can certainly make it a much less scary and uncertain place by positioning our portfolio accordingly! And maybe that’s a good thing – because no one should ever sit back and be complacent. If anything, it keeps us on our toes.