Are investors focusing too much on interest rates?

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Markets have been drifting lower recently. Investors are weighing the impact of interest rates that could potentially stay higher for longer. Well, our guest today says the current conditions are just a normal part of the business cycle. Joining us now to discuss, Peter Hodson, the founder and head of research at 5I Research. Peter, great to have you back on the program.

Thank you. It's good to be back.

So this is our [INAUDIBLE] September is known as not being a great month for stocks.

For stocks.

And it's been living up to its reputation. And this final week of September has been pretty choppy and volatile. We're all worried about the cost of borrowing. Do we need to get some perspective here?

Yeah, I think what investors need to do is they have to look back 20 or 30 years. So, absolutely, rates are much higher than they were two years ago because they were at 0%. So now, you've had this huge spike up in rates. And everyone, for lack of a better phrase, is panicking. It's like, what am I going to do now? But historically, they're not as bad, they're not as high as they've been in the past. They were much, much higher in the 80's, of course, in the giant inflationary period then.

And we're only back to, I think, 2006, 2007 levels. So if you turn things around, it's like, would you like to have been a buyer in 2006, of equities? Probably. Other than the financial crisis, you're still going to be ahead from that period of time. So what happens in an economy, things are doing well. The economy grows. There's high employment. There's higher inflation. And then the central banks tap the brakes. They put on the brakes.

They're going down this hill. They don't want to miss the curve at the bottom of the hill. So they tap the brakes some more. They tap the brakes some more. And that's the interest rate hikes that we've seen over the past couple of years. And then you either get a hard landing or a soft landing, or you don't get any recession at all. And you just kind of skate through that corner and continue on your way. So I really think investors need to stop looking at rates.

Obviously, if you're a homeowner with a mortgage, rates are important to you. But if you're an investor in a stock, in a company, you actually own a company, and if that company does not have any debt, then rates are not really going to impact them that much, as long as their customers keep coming in. Now, of course, there's a whole economic scenario where high rates means lower consumer spending. But what's happening right now is just a normal business cycle, economics 101, back in my university days.

This is what happens. Rates go higher. The economy slows down. And then you carry on from there. And most people are worried about recessions. Recessions are typically 12 months or less. And we've been talking about recession now for two years. I'm getting a little tired of talking about it. So some of it's priced in. Whether it's 1% priced in or 150% priced in, I can't tell you. But the pessimism there I think is a little bit too much, based on what companies are doing.

Now, if we want to be forward-looking investors, I understand, a part of the market you keep an eye on to try to figure out, not what people are trying to do in the here and now, but where we might be headed is private equity and some of their moves. Well, why is that a useful strategy?

I think it's useful because investors these days, as you know, are far too short-term-oriented. It's like, what is this company doing for me this quarter? Did this company beat expectations or miss expectations? And, oh my gosh, I have to react to that. But what private equity does, and corporations themselves, they look at longer term scenarios. So if you're a private equity player and you want to buy a company, and you're going to buy that company for the next 50 years, maybe it's cheap right now.

Maybe you can finance it at 5%. And that's a long-term growing company. The market's not valuing that company properly. So you're like, you know what? I'll take that company. I'll take it private. And I'll make all that cash flow for the next 30 years. So they look long term. So we really like to watch what companies like Blackstone and BlackRock and Brookfield are doing because they've got a ton of capital right now.

So if they decide to deploy that, then it means, well, at least there's an entity that doesn't think the world's going to end tomorrow. And they're willing to go for the longer term. Keep an eye on what Buffett does. He's sitting on a bunch of cash as well. And at some point, that's going to be deployed because the valuations are getting attractive for anyone looking beyond the current cycle.

Are they showing us anything interesting right now in terms of where we might be headed, or are they waiting and watching?

They're probably a little bit more waiting. But they do have a lot of capital to deploy. But you're also seeing corporations. So Cisco the other day made a $28 billion acquisition. That's their largest acquisition they've ever done. So they're not worried too much about what's happening. And it was what I would have said as a higher valuation versus some of the peers. But they don't care.

They're like, this is a company. We're going to buy it for the next 10 years and see what happens. And so I would like to see a little bit more M&A action. The IPO action is a little bit, it's positive. People are willing to give money to new companies. But I would like to see-- I'd like to wake up on a Monday morning and see five or six deals. That would be ideal for us.

That used to be a regular Monday morning in our business.

It used to be regular day.

You on your investing side, or me on the journalism side. M&A Mondays, we haven't had a lot of it. You mentioned the IPOs. It's interesting, we had Arm Holdings. We also had Instacart. There was an appetite right out of the gate. And then some people got a little critical, again, in the short term. They didn't like the second or the third day. I mean, how do you judge the health right now?

Well, I mean, the IPOs are always kind of wacko. And they get a lot of media attention. And really, there's some good ones, some bad ones. But I think just the fact that these are being done is a good sign. Obviously, there's so much speculation on the first week of trading. We just ignore that. It's like, look at it a month or two later and see how they're doing. But the appetite is there for risk, which is a little bit contradictory to the pessimism that's out there.

So any time you see an investor come up and say, OK, I'm going to make an investment in a brand new public company, it totally contradicts the fact that they're worried about everything. And we get a lot of incoming data feeds. And just the other day, somebody we follow closely basically said, we can't find anything positive to say.

And that, by default, is a positive because it means that maybe any positive news is going to be a super boost, when, actually, something good happens. So I think IPOs are always important to watch. But in the grand scheme of things, they're such a small slice of the market. I'd rather look at the rest of the companies.

Now, with the kind of September we had, we talked off the top, living up to its reputation, a bit of volatility in the markets. You talk about in terms of not wanting to take too many risks. You watch the IPO market to see what the risk appetite is. But from an investor perspective, do you need to be sticking your neck out at this moment?

No, I don't think you do. And we watch the IPO market. But we don't usually participate in it. I mean, I'd rather buy a company that's been around for a hundred years that's got a public track record. But absolutely, the valuations have changed so much. If you ex out the large seven mega-caps in the US, the S&P really hasn't done anything in two years.

And so, now, it's a situation where you can get a giant $100 billion market cap company that's been around for 50 years, that pays a dividend, that's got no debt, trading at very low valuations compared to the historical valuations. So there's really no need to buy a micro-cap or buy a concept company or a company that's trading at $1 billion that has no revenue. And there's lots and lots of those still out there.

Why not instead buy an established company that's been through five recessions, that pays you a dividend and has no debt? I mean, you really don't have to put yourself-- you don't have to be a hero. There's no need to gamble. There's no need to take a risk when other companies are trading at decent valuations.

Now, circle back to the top of our conversation, the fact that we're seeing bond yields move higher. People are worried about rates-- higher for longer. When we entered this year, a lot of market pundits, the markets themselves, were thinking that we'd be in the cutting territory by now. Is this a matter of just staying patient for longer? It didn't happen as quickly as perhaps we were anticipating.

I think so. And you can also look at it, if you want to put your rose-colored glasses on, every time we get a rate hike, it means we're closer to the top, just by default, obviously. And certainly, the economy's been much stronger than people expected. A lot of people, as we're saying, have been expecting a recession for 18 months now. And so the central banks have to be careful because there's a lag effect on all these rate hikes.

And you're starting to see it in consumer sentiment. You're starting to see it in some of the retailers. They're reporting not great numbers. Unfortunately, oil is ticking up, which is worrying people on inflation again. But certainly, there's not a lot of massive borrowing going on right now at the new rates when people are trying to get by and buy their groceries. So I think that lag effect will impact. And I think patience is key. But it should be the key anyway.

The investments that you're making right now, you should be able to survive for the next five years because you don't know what's going to happen for the next five years. So I think it's just a matter of time. Inflation, it went from nine to four. Maybe it hovers around four. And the central bank stays higher for longer. But again, that thought is working its way through the market.

And so it's starting to adjust for that as well. So it's not a great market. But again, what will be something good that happens? Maybe it's better margins, lower inflation, lower rates one day. Bond yields could come down. China could grow again. There's lots of things that could happen. But everybody's looking at all the bad stuff right now.

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