The Cost of Money

October begins against a challenging global backdrop. Geopolitical tensions continue to influence energy markets and international trade, while governments face difficult choices over taxation, spending and borrowing. At the same time, the artificial intelligence revolution continues to attract enormous amounts of investment, reshaping expectations for some of the world’s largest companies.

Closer to home, the UK faces many of the same pressures. Inflation has moved higher again, economic growth remains subdued, and the Government’s finances are under increasing scrutiny.

None of this automatically points towards a market downturn.  However, it does make one factor increasingly important for investors, governments and households alike: the cost of money.

When borrowing becomes more expensive

UK inflation rose to 3.1% in August, still comfortably above the Bank of England’s 2% target. Energy prices remain an important influence, with oil and gas markets particularly sensitive to geopolitical developments.

At the same time, governments around the world are carrying historically high levels of debt. Investors therefore have to consider not only inflation, but whether governments can continue to borrow at attractive rates.

The UK provides a good example. In September, the Government sold 30-year gilts at a yield of 5.82% – the highest level recorded since the Debt Management Office began operating in 1998.

Higher government borrowing costs matter beyond Westminster. They feed into the wider cost of capital and can influence everything from corporate borrowing to mortgage rates. For households coming to the end of fixed-rate mortgage deals, the prospect of higher-for-longer borrowing costs remains an important consideration.

Yet markets remain remarkably resilient

Against this backdrop, investors might reasonably have expected equity markets to struggle.  Instead, markets have remained remarkably resilient.

The FTSE 100 has returned around 11% so far this year, while global equities, as measured by the MSCI World Index, are up around 12%.

That apparent contradiction is worth understanding.

Markets are not simply responding to today’s economic headlines. They are constantly trying to price what they believe the world – and company profits – will look like several years from now.

That is why rising government borrowing, geopolitical uncertainty and higher interest rates do not automatically translate into falling share prices. If corporate earnings continue to grow, investors can look through considerable amounts of short-term uncertainty.

And then there is AI

The other major force shaping markets is artificial intelligence.

There are obvious reasons for investors to question whether expectations have become too high. Some technology companies trade on demanding valuations, while hundreds of billions of dollars are being committed to AI infrastructure.

But the difference between today’s AI boom and some previous technology bubbles is that the leading companies are already generating enormous revenues and profits.

Nvidia’s latest results are a good illustration. Quarterly revenue reached $96.2 billion, more than double the figure a year earlier, while data-centre revenue rose 117%.

That does not mean AI-related investments cannot become overvalued. They can. The more important question is whether the huge investment being made today ultimately produces sufficient earnings and cash flow to justify the valuations investors are paying.

For now, the spending is being supported by very real demand.

What does this mean for investors?

The common thread running through all of this is expectations.

Bond investors are demanding more compensation for lending to governments. Companies are having to consider the cost of capital when deciding whether to invest. Households are facing higher borrowing costs. And equity investors are trying to work out how much future growth is already reflected in share prices.

For long-term investors, this is another reminder that markets rarely move in a straight line. There will always be reasons to worry, particularly when the news cycle is dominated by geopolitics, inflation and government finances.

The important question is not whether uncertainty exists – it always will. It is whether the underlying businesses and assets we invest in can continue to generate attractive returns over the long-term.

And that, ultimately, is where the cost of money matters most.

 

How we are positioned

We do not believe the current environment calls for a wholesale defensive shift in long-term portfolios. Instead, we continue to favour diversified portfolios capable of participating in economic growth while retaining sufficient resilience to navigate periods of uncertainty.  One important difference compared with recent years, is that Bonds are once again offering meaningful levels of income. Higher yields have improved prospective returns across parts of the fixed-income market, providing investors with an additional source of return alongside equities.  At the same time, opportunities continue to emerge across global equity markets, particularly for active managers able to identify businesses with strong earnings, robust balance sheets and attractive valuations. Diversification therefore remains as important as ever.

Staying focused on what matters

When uncertainty rises, it is frequently investor behaviour, rather than investment fundamentals, that poses the bigger risk.  When headlines focus on inflation, government debt, mortgage costs, and geopolitical tensions, the temptation to make short-term investment decisions can be understandable. History suggests, however, that successful investing is rarely achieved by reacting to every news headline. Instead, we believe investors should remain focused on three core principles:

• Remain invested: Times of uncertainty can feel uncomfortable, yet some of the strongest market gains have historically followed periods of heightened concern.

• Maintain diversification: Different regions, sectors, and asset classes take turns leading performance, which reinforces the value of spreading risk.

• Expect volatility: Market fluctuations are a normal part of investing and can often create opportunities for those willing to look beyond the short term.

Final thoughts

Higher interest rates continue to influence governments, businesses, and households, but they also create new opportunities for investors. This reinforces the value of a disciplined, diversified portfolio that can adapt to changing market conditions.  While the headlines will continue to change, the principles of successful investing remain the same. Diversification, patience, and a long-term perspective continue to provide the strongest foundation for achieving long-term financial goals.