Rate increases are expected

By DAVID MOON, Moon Capital Management, LLC
November 17, 2013

For years, I have been a participant in the Barron’s magazine quarterly poll of institutional investors. The publication asks for opinions about the economy, stock market, individual stocks, interest rates and political economic situations.

I have often joked that while our individual predictions are all over the board, the average prediction or expectation of all of the poll participants always ends up being very close to the current levels of the items being forecast.

That is, you can find an opinion for about any position you want to hear, but the aggregate prediction of most institutional investors doesn’t provide much useful information. Our diverse opinions tend to cancel each other.

For example, one of the three most overpriced stocks, according to the Barron’s poll, is Apple.

Apple was also the most mentioned favorite stock in the poll.

That’s the sort of expert prediction that turns varied opinions into very average vanilla forecasts.

Experts seldom agree on anything. In the rare situation when they do, pay attention.

So pay attention to interest rates.

When asked about 10-year Treasury bonds, 94 percent of the Barron’s institutional investors responded that they expect rates to be higher a year from now.

That many people never agree about anything. I suspect not even 94 percent of Tennessee football fans would agree that Derek Dooley was a nincompoop.

The suggestive power of consensus is important because the investment markets react to surprises. When the government shut-down occurred, the investment markets yawned, just as they did when the government un-shut down.

Both were already expected, so neither was news.

Since we all know (or think we know) that interest rates are going to rise, what will happen when they do?

If the market only reacts to surprises, then nothing will happen. Barron’s says that 94 percent of all money managers already expect interest rates are headed higher.

And 100 percent of people I’ve met at recent Rotary Club speeches agree.

An increase in interest rates will surprise almost no one.

But run a web search on the phrase “what happens if interest rates never go up?”

I did. The only hit was a three-year old article about Berkshire Hathaway’s Todd Combs.

The riskiest question is the one that is least asked. What happens if rates don’t rise? What if the consensus is, as it often is, wrong?

If rates don’t increase, the people sitting around with cash waiting on higher CD rates will have earned another year (or two or three) of zero interest.

People who refinanced their mortgages with 30-year fixed rate loans will second guess the low rate ARM they swapped for the fixed mortgage.

It means the economy is likely still weak and the Fed is still QE-ing.

I expect rates to increase. I expected it last year. And the year before that. I am part of the 94 percent in the Barron’s poll.

But I regularly question what will happen to my investments if I’m wrong and rates don’t increase anytime soon?

You should too.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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