The Consequences of Negative Interest Rate Policies

Stock Markets Reach Record Highs… Again 

Both the Dow Jones and the S&P 500 indexes have climbed to all time highs in late July. 🙂 But corporate earnings have been stagnant and economic growth remains weak. Restaurant sales have slowed. The U.S. economy only grew a disappointing 1.2% in the second quarter, well below expectations. 😕

So what’s producing so much excitement in the stock market? In short, I believe it’s largely caused by Negative Interest Rate Policies (NIRP). For example, in Europe the benchmark lending rate is negative 0.4%. Usually the bond issuer pays interest to the investor. But with negative rates, the investor pays the issuer. Currently about 1/3rd of the world’s government bonds are producing negative yields. Investors can’t get rich by holding these securities anymore. So in this kind of environment bonds really hold people down.?

As a result of NIRP, more investment capital has moved from the bond market to relatively stable stocks. These tend to be companies that operate gas pipelines, railways, utilities, telecommunication services, and other infrastructure that are recession resistant. Last year I wrote about how to easily make $75 of annual income without using any of my own savings by using leverage to buy shares of TransCanada Corp (TRP.)

I purchased TRP stocks for $42 per share. I mentioned at the time that analysts had an average price target of $57.50 per share. This doesn’t always happen, but sure enough TRP is trading at roughly $60 per share today. 😀 So not only am I making $75 a year in dividends, but I’ve also made $1,800 in unclaimed capital gains so far. 😉

In normal circumstances this kind of price movement in a large cap, blue-chip company wouldn’t happen. But due to a lack of viable investment alternatives, an influx of additional buyers has pushed up TRP and many other relatively safe stocks.

Increasing Valuations and Risk

Unfortunately, NIRP produces asset bubbles and may cause the markets to behave precariously. The chief executive of DoubleLine Capital, who oversees more than $100 billion in assets, recently said that many asset classes look frothy and his firm continues to hold gold, which has also climbed due to NIRP.  At the end of July gold reached $1,350 per ounce, the highest monthly close in years! Stock investors have entered a “world of uber complacency,” said Jeffrey to the media. “The stock markets should be down massively but investors seem to have been hypnotized that nothing can go wrong.“

The reason precious metals are shining so brightly now is because investors would rather hold something like gold that produces no yield, than a financial asset that has a negative yield, like negative interest rate bonds, which actually costs investors money to hold.

According to CREA, the national average sale price of Canadian homes climbed 11.2% in June from one year ago. This causes unaffordability and is unsustainable. Once again, negative interest rate policies are at least partly to blame for Canada’s inflated real estate market. Global millionaires are looking for safe havens to store their wealth. Normally they are content with earning 2% or 3% in their sovereign bond portfolio. But today those bonds would cost them money instead of make them money. So they’re looking for alternatives, and real estate in politically stable countries are always ripe for the picking. A $1 million home in Toronto could be rented for $3,000 a month. This may net a 2.5% yield on investment after property tax and other expenses, which is a nice substitute for bonds that used to pay the same amount.

Hardly anyone complains about NIRP because its consequences are indirect and take time to manifest. And since it has pushed up the prices of just about every asset class in the world, investors have had little reason to condemn it. Anyone who holds a diversified basket of securities should have done very well recently. For example, my net worth so far this year has increased by about $100,000, mostly due to asset appreciation. By comparison that’s how much my net worth increased in all of 2015, which I broke down and explained in a previous post. But it’s wise to keep in mind that not everything is as it seems on the surface. This dichotomy of ever increasing asset prices in a world of static real wages and stagnant corporate earnings can’t continue forever. We should carefully watch how the economy unfolds in the next year or so.

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Random Useless Fact:

A study collected data from 2.4 million heterosexual interactions on an online dating app. It revealed that the majority of women are most drawn towards white men. And most men prefer Asian women.