There is regular investment commentary in the popular press that a rise in interest rates in Canada (and the U.S.) is inevitable and will lead to a significant pullback in overall investment returns.  Let’s analyze these two arguments in more detail and look more into Investment Returns and Interest Rates.

On the notion that rising real rates in Canada are inevitable, we present the following chart on Long Term Canada real interest rates. long-Canada

As can be seen, the real rate of interest has been in decline since it peaked in 1994.  The jump in real rates occurred between 1975 and 1994, propelled initially by the significant inflationary  pressures which began with the oil shock of the mid-1970s.  This 1975-1994 period was one of high inflationary expectations which were countered by monetary authorities rigidly intent on controlling the direction of the economy by way of a doctrine of tight money supply.  Only when there was a change in the monetary authority regime and a revised policy style of accommodative money policy did real rates begin their long decline.

This change, in turn, greatly aided economic growth, but also opened up the possibility of private speculative activity by large financial institutions that were suddenly awash in cash.  The result was the financial crash of 2008.  Since then, though monetary policy has remained relatively unchanged, regulatory authorities have taken a tougher stance on the oversight of these large financial players.

Are rising rates inevitable?  Not necessarily – at least not any material rise in interest rates.  There may be some marginal upward movement as monetary authorities tweak their policy and are encouraged to exhort a tough stance, but there is no fundamental reason for monetary authorities to abandon their accommodative policy.

Will any interest rate rise automatically lead to a significant pullback in investment returns?  I would argue no.  Any rise in rates will be modest since there is no corresponding inflationary pressure (indeed, there is deflationary pressure around the world).

This means that investment returns will be driven by economic fundamentals, not by the whims of monetary authorities.  Keep an eye on corporate profits, dividend yields, and global industry trends to determine an appropriate investment portfolio composition going forward.  A value-based investment strategy  utilizing stock-picking (based on corporate cash flow, dividend yield, and corporate strategy) will outperform.