Interest rates have been at record lows since 2009. And they're likely to stay that way for some time to come. So what does that mean for your investments? John Stepek explains.
Intrest rates across much of the developed world have been at record lows since 2009.
Central banks are still trying to do the same thing that they did all the way through the boom years. When we come to a bump in the road, they simply reduce the cost of money to get everyone lending and spending again. They used to do this by cutting interest rates. When those hit zero, they started printing money instead.
But try as they might, they haven't been able to reignite the boom times. In fact, zero percent rates may be doing more harm than good, as we'll see in a moment.
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Yet, regardless of what harm they're doing, it seems unlikely that the banks will reverse strategy now. So what will that mean for your investments in the year ahead?
Zero interest rates are damaging the economy
The world's biggest investors seem to be finally twigging that zero percent interest rates are bad for an economy. For example, US fund manager Bill Gross points out in a good piece in the Financial Times today, just how damaging ultra-cheap money can be.
To stop half the known world from going bankrupt, the Federal Reserve and other Western central banks have deliberately tried to drive down the yields on 'risk-free' (they're not, but that's how they're perceived) government bonds to near-zero. And they are promising to keep them there.
The trouble is, while this has been enough to prevent various heavily indebted companies and individuals from going bust, it has also slashed the returns available to people with capital to invest.
You cannot get a 'risk-free' return on your money anymore (for more on the 'risk-free' rate, see my colleague Tim Bennett's video: Warning: the City's formula for pricing shares is bust). If you put your cash in a US Treasury, or a UK gilt, or any other government bond still deemed 'safe', then after inflation, you'll be losing money.
So if you want a 'real' (after inflation) return, then you have to put your capital at risk. However, the rewards for doing so simply don't make it worthwhile. Given that we could face a repeat of 2008 at any moment, the markets should be offering some pretty big carrots to investors bold enough to put their money to work. Yet you have to take some substantial risks just to break even after inflation, let alone make any decent money.
Trying to punish savers just makes them save harder
Worse still, the financial system itself is a minefield. The collapse of MF Global has dealt another damaging blow to investor confidence. As Gross points out, "if an investor has money on deposit with an investment bank/broker that not only appears to be at risk but returns nothing, then why maintain the deposit? Perhaps an investor would be more comfortable with a $100 bill at home in a mattress than a $100 bill on deposit with a broker".
In short, risk remains very high, while potential rewards are too low. Investors now don't worry about growing their capital. They worry about hanging on to as much of it as possible, to the point where they are willing to take a guaranteed loss after inflation, rather than risk it on anything more adventurous.
Sure, Gross is talking his book. He's a bond investor. He's not having fun with yields at these levels. But he's also right. His point is not very different to the one we've often made about Japan.
The zero interest rate policy (Zirp) has hindered at least as much as it helped there. If you try to force savers to spend by driving interest rates on savings accounts below inflation, then you just panic them. They see their savings losing value, and it makes them save all the harder. That in itself is deflationary, particularly if they start withdrawing funds from the system altogether, as in Gross's example.
And if, at the same time, Zirp is preventing bad businesses from going bust and having to sell assets at bargain prices, then there is no reward around big enough to tempt people with spare capital to start investing.
I still believe that the best thing for the economies in the West would be for interest rates to start rising. It would be painful for a lot of people. But you'd get asset prices to clearing levels pretty quickly.
But it doesn't matter what I think. What matters is what will happen. And so far the world's central banks are happy to stick with the Zirp strategy. So what does that mean for your investments?
Why real assets are in demand
A Zirp world is a deflationary world. But we've got currency debasement on top of that, when central banks print money to try to offset deflation. How do you invest for that?
Gold is an obvious option. In a world where everyone is worried about bankruptcy, it's no one else's liability (assuming you have exposure to the physical gold). It won't go to zero. And if and when currencies are debased by more quantitative easing (QE), it should hold its value. That's why I'm still happy to hold it as portfolio insurance in the long run.
Other 'real' assets have been very popular too. I think luxury markets such as wine, art, collectible cars, central London property and the like are very overpriced just now, particularly as China is looking very wobbly indeed. I wouldn't buy into them.
But I can see why very wealthy people have been piling in. On the one hand, they are worried about eventual inflation. But in the here and now, they are also worried about the security of their money. And one thing you can say for a painting, or an apartment in London, is that like gold its value might fall, but it won't ever go to zero. Most of the time, this isn't much of a selling point. But at times like these, the mere fact that your downside is less than 100%, can be very attractive.
Moving away from 'real' assets to paper ones: you have to find the paper assets that can survive a tough environment. We've said it again and again, but that means high quality, global stocks paying decent dividend yields. And watch out for rapacious governments. They need tax revenues companies with cash are prime targets. That's why you want global companies. They have the best ability to minimise their tax liabilities.
And there are other markets that look interesting. Our Roundtable experts have some strong ideas on which ones they give their views, along with 16 individual tips, in the next issue of MoneyWeek magazine (out on Friday). If you're not already a subscriber, subscribe to MoneyWeek magazine.
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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
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