ONE of the tremendous benefits of an expanded writer base — and by extension, team — here at SSL is the time it allows for clarity of thought and the opportunity to grasp issues as they surface in the global capital markets. Those in the know will be aware of recent debates surrounding the continuation of the third round of Quantitative Easing (QE3 – Government Bond Buying) by the USA’s Federal Reserve, which has led to the recent rise in 10-year USA Treasury yields by 40 per cent to 2.61 per cent, the highest since August 2011. The 10-year Treasury rate was 1.63 per cent in May 2011.

Were it an event in isolation, it would not be worth mentioning; the implications, however, are far-reaching both globally and in terms of asset classes, hence the title of connectivity. A glaring example which attests to the connectivity of interest rates and investment instruments occurred as the fourth quarter (Q4) of 2009 was ushering in the year 2010. At that time, there were whispers of a forthcoming debt swap (which became known as the Jamaica Debt Exchange — JDX) and Jamaica’s Sovereign bond prices plunged (yields rose) significantly. Buyers of Government of Jamaica (JAMAN) Global bonds at the time did so at great discounts ($0.70 – $0.85 on the dollar).

This signals market pessimism on Jamaica, for good reason, as a debt swap is by no means a good thing. This was the case for December 2009 as yields on the 10-year JAMAN Global Bond (2019) were 11.26 per cent on the US dollar. Subsequent to the JDX, the benchmark 180-day JMD Treasury Bill rate fell from 16.80 per cent at the end of 2009, to 10.49 per cent at March 31, 2010. Connectivity manifested itself, with a subsequent fall in Global Bond yields to 7.89 per cent in March 2010.

Having established the theory, here are a few questions to consider. Firstly, if as expected, global interest rates continue their upward trend, how will corporate and sovereign bond yields be affected? They would rise, one could reasonably assume.

Secondly, what is the likely impact on equity markets? One could guess, or assume, that the rate of return expected of equities would have to rise in a similar manner to compensate for an increase in interest rates. This means that, stocks bought for dividend yields (such as most of those on the Dow Jones Index) could begin to lose appeal, or pale in attractiveness to those that bear significant capital growth potential.

Lastly, what would the impact of higher interest rates be on real estate? If fixed income yields rise – which is again, an on-going process — isn’t it possible that real estate yields would also need to correspondingly rise? Opportunity cost is real. That said, could such a scenario be accommodated in today’s economic climate? Let us briefly examine the case. If the rental rate on a $16 million dollar, two-bedroom home is $100,000 per month, this equates to an annual return of $1.2 million. When divided by $16 million, the annual yield equates to 7.5 per cent before the inclusion of maintenance costs incurred by the proprietor. To match the 8.75 per cent yield offered by the JMMB 2016 Preference Share listed on the Jamaica Stock Exchange (JSE) today, the monthly rental would have to be increased by roughly 17 per cent to $117,000.

Faithful reader, are you able to accommodate a 17 per cent increase in your rental cost at this time?

Kindly note that in a market of ascending interest rates, this scenario is a lot closer to reality than many proponents of real estate would dare acknowledge! In a fiscal playground where many have packed up their marbles and gone home, many would say it cannot be accommodated. A glance at the converse will affirm that if property prices are increased, rental will also have to increase or else yields will fall!

It is not impossible, but in an economy of reduced disposable income, renters would either have to sacrifice expenditure elsewhere in their budget (food, discretionary spending) or rent a more cost-effective facility. Friends, is it therefore any wonder that children are taking longer to move out of their parents’ home, food retailers (who shall remain nameless) are having tough times, and ‘for sale’ & ‘for rent’ signs continue to litter our nation’s sidewalks?

In times where liquidity is king, the ability to exit a ‘liquid’ investment in T+3 days (three business days after the trading day) is slightly more convenient to waiting three months or more for the proceeds of a property sale.

As a practitioner in a field where SSL’S equity picks have done very well — most notably Nike (NKE), a recommendation which beat results and climbed three per cent in after-hours trading on June 27 — this writer is acutely aware of the benefits to be gained in the capital markets. Having said it all in this article, however, the concluding question is — given connectivity of interest rate yields, their current incline and the preciousness of liquidity, would one really want to be overweight in real estate at this time?

Ryan Strachan is the Manager of the Wealth Division at Stocks & Securities Limited and can be contacted via rstrachan@sslinvest.com