The BoE’s benign bank rate bump
Welcome to the rate-hike club! Brits are finally living through what yanks experienced nearly two years ago: the first local rate hike of this bull market. Don’t sweat it. Initial rate hikes don’t kill expansions.
I’m half-surprised Bank of England (BoE) chief Mark Carney’s tiny rate rise sparked many headlines. Yes, it is the first hike in a decade. But raising the bank rate to 0.5% puts it right where it was from March 2009 until last August. A pretty great 7.5-year stretch! UK stocks rose 150% in that span. The economy grew fine. Markets know Britain can handle rates at this level, because it already did.
Then, too, we have a long history of rate moves and subsequent stock returns. Excluding the present, we’ve had nine initial BoE rate hikes since 1970, when America ditched the gold standard and the modern central banking era began.
Over the following 12 months, world stocks averaged 12.8%, positive eight of nine times. Two-year forward returns improve to 14.8%, on average. UK stocks also fared fine, averaging 9.2% in the first 12 months and 14.7% over two years.
In both windows, UK stocks rose seven of nine times. Those declines came from global bear markets, little swayed by the first small moves in UK short rates.
Need more? The US Fed did its first rate hike of this cycle on December 15, 2015. The S&P 500 returned 13.2% over the next year, despite a deep correction that began seven months before the Fed acted and ended two months afterward. Total S&P 500 returns since then are 31.2%.
Rate hikes don’t predict anything, good or bad. Relative returns afterward are mixed. Sometimes the US outperforms after rate hikes, sometimes not. Same for Britain. Short rates are just one economic driver, not so influential on their own.
What matters more? The yield curve spread-the difference between short-term and long-term rates.
Banks borrow at short rates, lend at long rates and profit off the spread. So wider spreads usually mean more lending, smaller spreads less.
The BoE’s rate hike shrank the spread some, but we’ve seen smaller during this bull market. For most of 2016 and 2017, the yield spread was smaller than it is now.
Yet loan growth and broad money supply surged. My theory? While the spread was slimmer, the madness of quantitative easing was gone. Banks had one less variable-BoE intervention with long rates-to worry over. Free of this uncertainty, they lent more. It shouldn’t be different now.
To me, the primary takeaway is policymakers’ universal confusion about inflation. For years, Carney, Janet Yellen, Mario Draghi and all the rest have complained about inflation being “too low”. They saw improving labor markets and couldn’t fathom why wages and prices weren’t rising.
They forgot the sage wisdom of my all-time favorite economist, Milton Friedman: Inflation is always and everywhere a monetary phenomenon. Why did UK inflation pick up when US and eurozone prices didn’t?
Simple: UK lending and M4 grew much faster than US and eurozone! As Friedman taught, in the long run, broad money growth equals the real economic growth rate plus inflation. If you don’t have inflation, it’s because there isn’t enough growth in the quantity of money. The UK finally had rip-roaring M4 growth last year, hence, inflation. When will central bankers learn?
Maybe never, but that’s an academic question, not a market driver. What matters now: rate hikes in Britain and America don’t endanger the bull market. Keep owning stocks like these:
Europe and Asia are collectively leading US stocks for the first time in years. Leaderships don’t flip fast, so expect the trend to last. One way to take advantage: buy big international healthcare, like Australia’s largest healthcare firm, CSL Limited.
CSL is the global leader in immunoglobulin, a fast-growing market as Western populations age and diagnosis of immuno-compromised patients improves. Its rare disease drugs business is growing hand-over-fist, adding a second engine to the business.
Or, try Japan’s largest healthcare firm, Takeda Pharmaceutica (TKPYY)l. Takeda derives the largest part of its earnings from Japan, a rapidly aging society, with a strong product presence in cancer, inflammation, gastrointestinal, and mental health.
Both firms are pricier than peers at 29 times my 2018 earnings estimate, but buy anyway – industry leaders with big growth prospects get bigtime investor love as bull markets mature.
This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
Ken Fisher has been regularly featured in the financial media for over 30 years and was the pioneer of the Price-to-Sales ratio as a tool for investment analysis. Since 1979, Fisher Investments and its subsidiaries have provided customised guidance to institutional and individual investors. For more information on Ken Fisher and Fisher Investments UK please visit www.fisherinvestments.com/en-gb.