That is a question that has been floating around for a few weeks now. Are we headed for the same type of deflationary cycle that has gripped Japan for more than 20 years now? I certainly hope not and I don’t think we are. But, we may suffer a mini Japan before this is all over.
When bubbles burst, especially those that involve every segment of the population, the populous acts like a patient in shock. In this case Americans are staring in disbelief at falling home values. In many parts of the country the values have fallen to the same level as ten years ago, long before the boom. Sentiment towards home ownership is negative with many swearing of the thought of ever buying a home again. Fortunately we have very short memories and that is why we will not be another Japan.
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Right now de-risking and de-leveraging are the catchwords of the day. Nobody engages in either voluntarily. They must be shocked into it. This process, which is akin to tearing up your credit cards, takes a good bit of time to flow through the system. As a population we are impatient. We are used to things resolving in no time flat. If there’s a fire, we put it out. If the levy breaks, send in the Army Corps of Engineers and a couple of million tons of cement…NOW!
Deleveraging is not a quick process. It has taken decades to build up so much consumer debt and the same amount of time to create unsustainable spending habits. The problem that is occurring is that this deleveraging in hitting home psychologically and that is a problem that cheap money can’t fix. And, that cheap money will be staying for a while. Here is an excerpt from Janet Yellen, the President and CEO of the Federal Reserve Bank of San Francisco:
In normal times, the Fed raises interest rates by reducing the size of its balance sheet, say by selling Treasury securities to the public. This draws in cash from the economy, or, as we say, reduces the supply of bank reserves, which in turn causes the price of those reserves, that is, the federal funds rate, to go up. Since the fed funds rate is the benchmark for banks’ cost of money, other short-term market interest rates tend to follow suit. Higher interest rates in turn help slow the economy and reduce inflationary pressures.
But these aren’t normal times. Our securities purchases have caused the quantity of reserves in the banking system to swell to something like $1 trillion–far above the pre-crisis level of around $50 billion. If we were to follow our standard approach of selling securities to raise interest rates, we would have to sell off many hundreds of billions of dollars of securities to reduce the supply of reserves enough to have any chance of pushing rates higher.
The Fed, once the driving force behind monetary policy and stimulus is for the most part impotent now. Rates are at zero for all intents and purposes, negative really if you factor in inflation. Basically, the Fed is paying people to borrow money and still they are not doing so. That, my friends is the definition of a shock to the system. But, it will change.
The reason that we are not Japan Part II is that we are psychologically trained to want to buy more and better goods. Look at the I-Pad from Apple. Who really needs it? What about Season Tickets to the Miami Heat? Apple’s I-Pad sold out in days at an average price of $649. Miami Heat Season Tickets sold out in days after the signing of LeBron James. Disney just raised ticket prices. BMW sales are at the highest levels in company history. These are signs that while deleveraging is taking place, we have not become a nation of savers by any means. The Fed knows this and is playing a waiting game. They understand that while there has been a shock to the system, possibly the biggest in a generation, we are programmed to spend. And, we have short memories. This bodes well for US stock prices at some point in the future- it’s anyone’s guess as to when that point will be.
Investing in a Low Rate World
Low rates are here to stay for a while. This means that you are getting nothing from your cash in the bank. Exactly what the Fed and Treasury wants you to get. As fears of inflation and an ever-postponed retirement begin to play in your mind, you will soon turn to the markets to re-risk your portfolio. You’ll look for opportunities in business, yes, even real estate. Sitting still is not an option we are used to.
That being said, there are ways to make sure that you are not only going to make more money than if you left it in the bank, but also to participate in the markets if and when they turn. Of course, as with any investment you face real choices. If you invest and panic, you will lose money. If you do nothing, you will have your money, but it will be worth less as time passes.
There are a myriad of investments available today in solid blue chip companies where you can collect more than .25%. The tops on my list are Verizon (VZ-NYSE) currently paying 6.5%, Pfizer (PFE) paying 4.5%, French energy giant Total (TOT) paying 5.2%, Norwegian energy giant Statoil (STO) paying 4.3%, and a couple of utilities, Consolidated Edison (ED) paying 5.1% and Progress Energy (PGN) paying 5.8%. Each of these companies is fundamentally strong with positive cash flow, strong earnings and cash in the bank. They may not be the growth engines like Apple or Intuitive Surgical, but they are much more likely to give you a good return on your capital…as well as the return of your capital!
Make no mistake; low rates are here to stay. This will stimulate growth at some point, causing rates to move higher. When that time comes, stocks will have already moved in anticipation, and when those rates move higher they will do so slowly and to level not much higher than today. So, do yourself a favor and start collecting some real dividends on your cash today.
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Best Regards,
Kevin Raymond
