It always amazes me. At times when the market is clearly at an extreme individuals will continue to place bets that the market will continue in that direction. At the top of the .net bubble, investors were still betting that internet stocks would go higher. When the housing bubble was near its peak people were buying up houses as investment properties, expecting the continue to make double-digit returns each year. Now we are looking at some of the lowest interest rates in years, yet individuals continue to believe that interest rates will remain low, at times even making bets on lower interest rates. When you are seeing interest rates on bank accounts at zero, how much lower can you expect to go?
It is true that the Federal Reserve is trying to keep interest rates down to spur economic growth. The trouble, however, is not that there is not sufficient capital out there to invest. Banks have their vaults full of money available for lending, but no one wants to take out a loan. Likewise, companies are sitting on more money than they have in decades, yet none of them have anything they want to invest in. The Fed has kept short-term (read bank account) interest rates low by flooding the market with liquidity. They also tried the unusual step of trying to lower long-term rates by buying long-term treasuries. So far this has met with limited success (read, abject failure) as long-term rates have actually started to rise. For example, 15-year housing mortgage rates have risen by about 1/2 percent off of their lows. The trouble is that people see a weakening of the dollar which will lead to inflation. No one is therefore willing to lock in a 4% rate for 20 years if they expect inflation to be running at 5-10% or higher during that time.
So what do higher rates mean to the investor? Typically, not good things. As rates rise bond prices will fall (such that the effective rate of interest rises as well). Stock prices will also tend to fall as investors expect higher potential returns from stocks to justify the added risk over bond investing. Higher rates also have a dampening effect on inflation as well, so gold investors will also see their investment shrink.
In general, the best course is to raise cash and invest regularly as rates rise and stocks and bonds fall. If we ever see the 20% interest rates in bonds that we saw in the 1970’s one could lock in a great interest rate for 20 years or longer. One cannot sit in cash indefinitely, however, since these things can take quite a while to unwind. As always, the procedure of saving from earnings and regular investment is the key.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. In addition the writer of this blog is not an accountant and writings should not be taken as tax advice which should be left to a CPA. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing