Asset Valuation and Portfolio Movements

Every financial asset, from bonds to shares or real estate, represents a claim on future cash flows. The price an investor pays today depends on three factors:

• 1. How much cash the asset is expected to produce, and when.
• 2. The level of interest rates, which sets the baseline return available without taking risk.
• 3. The extra return investors demand for taking risk.

Economic headlines influence markets through one or more of these channels. Identifying the relevant channel helps explain portfolio movements.

It’s About Expectations, Not Headlines

Markets reflect future expectations, not past events. Widely anticipated data is typically already priced in. Surprises move markets, which is why markets may fall on “good” news if results do not meet expectations.

Interest Rates and Growth

Interest rates are typically higher in faster-growing, less predictable economies, as investors require greater incentives to save. Central banks adjust short-term rates throughout the cycle, lowering them when growth and inflation are weak and raising them when the economy overheats. Prolonged periods of rates that are too low or too high can amplify economic cycles rather than stabilize them.

What the Yield Curve Tells Us

Long-term bonds usually yield more than short-term bonds to compensate for longer commitments and inflation uncertainty. When short-term rates exceed long-term rates, the yield curve inverts, signaling expectations of falling rates and inflation. Historically, an inverted curve has often preceded recessions.

Government bonds typically provide a cushion during downturns, while equities, credit, and property are more sensitive to the economic cycle. Though this has not been the case since 2020, as inflation expectations and an AI productivity and investment driven economic bull cycle both emerged after a prolonged ultra low rate environment. As interest rates normalize, I believe the bond-equity correlation will break and we will return to traditional markets where government bonds are a haven in economic downturns.

Credit: Cheap in Good Times, Costly in Bad

Corporate bonds offer higher yields than government bonds to compensate for default risk. The credit spread narrows in strong economies and widens during downturns when defaults increase. Lower-rated bonds often outperform during recoveries, while higher-quality issuers are more resilient in slowdowns. Cyclical sectors like airlines are more affected than defensive sectors such as consumer staples.

Equities: Rewarded for Bearing Risk

Shares decline most during economic downturns, when investors rely on their savings. As a result, investors require a premium to hold equities. Historically, developed-market equities have outperformed government bonds by about 3–5% annually.

Valuations fluctuate with the economic cycle. Price-earnings ratios expand when rates are low and confidence is high, and contract when these conditions reverse. Historically, buying at high valuations has resulted in weaker returns over the next decade.

Property: Part Bond, Part Equity

Commercial property offers stable, bond-like rental income and equity-like exposure to property values. While rents are generally stable, capital values can decline sharply during recessions. Because property is difficult to sell quickly, investors require an additional return for illiquidity.

In Singapore, private clients also participate in the real estate asset class through Singapore REITs. They tend to provide stable cash flows, but at the same time are very sensitive to interest rate cycles, since the value of future cash flows falls in a high interest rate environment. As high interest rates are normally accompanied by economic upcycles, that can make REITs outperform long-term fixed rate bonds in this scenario.

What It Means for Portfolios

• All assets respond to the same three channels, but to varying degrees.
• Adjust positions for the economic cycle while maintaining your overall plan. Tactical shifts are most effective within a disciplined strategic allocation.