Who's afraid of rising interest rates?

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#1
Business Times - 18 Dec 2010

SHOW ME THE MONEY
Who's afraid of rising interest rates?


Data shows rising interest rates do not necessarily spell doom for the equity and real estate markets

By TEH HOOI LING
SENIOR CORRESPONDENT

I HAD lunch with a friend yesterday. He's someone whom I knew of more than a decade ago as an analyst, and a friend's colleague. We recently reconnected at another friend's housewarming. Before yesterday's lunch, I only knew him as a really smart and, yes, 'cocky' guy who made enough to retire at 32 so that he could lead the life he always wanted. He wanted a life which could give him the luxury of time - to read up on or research on anything he wanted, and to be around his family and watch the kids grow up.

And he's been doing that for 10 years now. All this while, he's been managing his own portfolio and just as in his career, he has done exceeding well at it. He said he learnt his lesson during the Asian financial crisis when his portfolio plunged to zero as he had concentrated his bets on three Thai stocks which were subsequently delisted.

Tell-tale signs

Seeing the tell-tale signs of another crisis coming, in 2007-2008 at the onset of the global financial crisis, he had about 60 per cent of his portfolio in cash and gold. At the worst point of the market panic, his equities portion dwindled to just 10 per cent of his portfolio.

But he reckoned the only country which could ring-fence itself from the global crisis was China. He kept his powder dry until the Chinese government announced its massive fiscal stimulus plans. Then he bet big on the emerging giant by buying up A-shares and H-shares and exchange-traded funds. He pledged some of his holdings so as to buy more. As a result, he emerged from the crisis with an even higher net worth than before.

Still keeping to the discipline of putting down his thoughts on 'paper' as per his days as an analyst, this friend will circulate some of his views among his friends as and when he observes something interesting in the market.

During lunch yesterday, he said that this time last year, one of the major concerns in the market was: 'When will interest rates go up?' But as he put it, he hasn't been hearing a lot of chatter about interest rates of late when in fact interest rates are already ticking up. 'The markets are terribly complacent about the possibility of rising interest rates.'

He pointed out that the yields on 10-year and 30-year US Treasuries have been rising in the past three months. Meanwhile, the short-term rate perked up in the last three weeks. Even in Japan, the 10-year government bond yields are on the rise in the last three months. 'Only in Singapore is interest rate showing no signs of escaping the force of gravity! But ask yourself for how long?' he wrote in his report which he sent me later in the day. 'Rising interest rates is one enormous fat-tail risk that nobody seems to be talking about.'

The three-month borrowing rate of the Vietnamese dong is now 12.6 per cent, he noted. 'Try to imagine what this would do to your portfolio if this occurred all over the world? Instead of thinking about how much more money to shovel into emerging market assets, start thinking about protecting yourself from such a possibility,' he warned.

You can see the 10-year yield for US Treasuries and three-month borrowing costs in Shanghai rising in the first chart. Singapore's interbank rate, however, is still flat.

But does rising interest rate necessarily spell doom for the equity and property markets?

Not really. In early 1988, the one-year Singapore interbank rate rose from 3.8 per cent to 7.8 per cent by June 1990. During that time, the Straits Times Index (STI) climbed by about 60 per cent.

In 1994-95, and during the Asian financial crisis, rates climbed and stock prices fell. But in the early 2000, both rates and stock prices fell in tandem. And they climbed in tandem between 2003 and 2006. The global financial crisis brought both stock prices and interest rates down. And in the last two years, while rates have stayed low, stock prices have rebounded strongly.

So if interest rates are firming because economies are growing, then it may not be all that bad for stocks.

Similarly for properties in Singapore. From late 1987 until 1990, rising interest rate did not deter private property prices from appreciating. The pattern is similar to stocks - after all, stocks are supposed to be a leading indicator for the property market.

Interest rates, of course, are the rates with which future cash flows of companies are discounted at to arrive at its value today. The higher the rate, the lower today's value should be - unless, of course, the future cash flows are expected to rise faster.

In the property markets, meanwhile, a higher interest rate would hit property owners immediately in terms of the monthly mortgage payments if the loan package is a floating rate one.

In my next few charts, I've updated the state of the Singapore property market now in terms of rental yield and returns from a residential investment property.

The gross rental yield, that is before all the related expenses such as maintenance and property taxes that a property owner has to pay, of a private non-landed property is just over 4 per cent. This is based on the third-quarter numbers from the Urban Redevelopment Authority of Singapore. That's still quite a bit of buffer compared with the interbank rates now.

Rental yield

Indeed, based on current market rates, the monthly rental from a typical non-landed private residential property is more than enough to cover the monthly mortgage payment. This assumes an 80 per cent loan quantum and loan tenure of 30 years. It also assumes that the rate is 1.5 percentage points above the one-year interbank rates.

But that buffer will disappear if interest rates rise by more than 50 basis points.

According to data from Bloomberg, the one-year interbank rate in Singapore is currently 0.85 per cent. The Economist Intelligence Unit is forecasting that Singapore's money market rates would rise to 1.3 per cent next year, 2 per cent in 2012 and 2 per cent in 2013.

So property investors should prepare for the day when rental may not entirely cover their mortgage payments.

How about return on equity (ROE) for a property investor? Based on today's prices and rentals rates, there is still a decent return of 7 per cent on the investor's equity of 20 per cent of the value of the property.

Again, this assumes 80 per cent loan. But the rental has been net of maintenance charges and the 10 per cent property tax. The ROE will be reduced to zero when Sibor hits 2.6 per cent. But then again, in the third quarter of 2006, ROE for holding a non-landed private property was negative. The following 11/2 years, however, saw a sharp jump in property prices in Singapore.

Ultimately for properties, it comes down to supply and demand. Yes, we will see a rather large amount of supply coming on to the market in the coming few years. But counter that with the draw of Asia as the fastest-growing region in the world and it is not hard to see why some of the richest people would want to park some of their money here. Meanwhile, the government's commitment to raise the median income of Singapore residents in the coming few years will further enhance the affordability of private properties to local residents.

As long as interest rates don't spike up to ridiculous levels, as my astute friend puts it, there continues to be upward pressure on property prices in the next few years.


The writer is a CFA charterholder
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#2
(18-12-2010, 07:25 AM)Musicwhiz Wrote: I HAD lunch with a friend yesterday. He's someone whom I knew of more than a decade ago as an analyst, and a friend's colleague. We recently reconnected at another friend's housewarming. Before yesterday's lunch, I only knew him as a really smart and, yes, 'cocky' guy who made enough to retire at 32 so that he could lead the life he always wanted. He wanted a life which could give him the luxury of time - to read up on or research on anything he wanted, and to be around his family and watch the kids grow up.

And he's been doing that for 10 years now. All this while, he's been managing his own portfolio and just as in his career, he has done exceeding well at it. He said he learnt his lesson during the Asian financial crisis when his portfolio plunged to zero as he had concentrated his bets on three Thai stocks which were subsequently delisted.

OT here but felt compelled to query is it really possible to retire at 32 from career? I did a projection of my career life with living expenses to only maybe amass 300K cash + 1 property (on leverage) when I reach 40 years old. My personal target to reach 10mil seems only possible when I reach 65. I really wonder how is he able to do it?

From a career perspective, those earning the most based on fixed pay at age 32 are bankers whom usually are AVP or VP level at best which constitutes to perhaps 200k per annum. To reach that income level is quite difficult in sales as well. Even as a property agent, it means you would have to sell 10million worth of properties in that year.. The only possible way is either own your business and be very successful in it (what are the chances?) or be already in the top level management (means you have backing or know some big-shot).

Perhaps he did it as an investor like warren buffet style getting compounded 20% returns since his early 20s. Even so, he would require maybe 100k of capital to start with. How did he managed to do it?

Its really inspiring to know his success. Demoralising as well when I look back realistically on my own future..
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#3
If he is as good as the reporter makes him out to be, he might have risen very fast as from an analyst and did well in his career.

Its hard to tell without more information. You don't know if he had a searing hot career and earned superlative bonuses for a period of time, or he came into an inheritance, or was well-to-do to start with, and so on.

Everyone's circumstances are different, so don't feel demoralised
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#4
i thought it was mentioned in the article. if u could spot the opportunity and do the few critical steps correct, few millions is achievable for normal working/saving people. 10 millions may needs 2 or 3 opportunities.

(18-12-2010, 07:25 AM)Musicwhiz Wrote: Seeing the tell-tale signs of another crisis coming, in 2007-2008 at the onset of the global financial crisis, he had about 60 per cent of his portfolio in cash and gold. At the worst point of the market panic, his equities portion dwindled to just 10 per cent of his portfolio.

But he reckoned the only country which could ring-fence itself from the global crisis was China. He kept his powder dry until the Chinese government announced its massive fiscal stimulus plans. Then he bet big on the emerging giant by buying up A-shares and H-shares and exchange-traded funds. He pledged some of his holdings so as to buy more. As a result, he emerged from the crisis with an even higher net worth than before.

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#5
I guess if you can spot mega-trends, then you can be considered a savvy macro-investor. People like me can only spot micro stuff within financial statements, so perhaps I cannot apply this method to earn big bucks. Tongue
My Value Investing Blog: http://sgmusicwhiz.blogspot.com/
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#6
If you were a macro-investor, MW, we'd probably lose you to CNA forums. Lol
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#7
Join both forums to benefit la..

CNA forum very crappy..

Makes my day everyday..

LOL
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#8
His current age is probably 42. (32 years old retired and doing self investment for 10 years).

Asian crisis happened in 1997-1998. That actually means that he was 29 years old in 1997.
So, after his portfolio went to zero in 1997, he managed to retire 3 years later in 2000 at 32 years old.

He probably made his money during the dot-com bubble period.



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#9
If he made millions during dot come period, he would probably leverage alot or use risky instruments to trade. This type of trading mentality dies hard and usually do not have a happy ending.

But from the article he sounds like a fundamental kind of guy. Maybe he has similar capacity of great investors like Soros.
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#10
hi all, i am sure the thought of rising interest rates has come into our mind at some point of time. any views on what industry/companies would benefit in a rising interest rates environment?
https://www.mckinseyquarterly.com/Econom...rates_2737

overall, equity markets should dip since cost of capital increases. banks should benefit from a wider interest margin.
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