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The Mechanics of Absurdity
The Mechanics of Absurdity
Over the past few decades, the central banks, including the Federal Reserve (Fed), have relied increasingly on interest rates to help modify economic growth. Interest rate management is their tool of choice because it can be effective and because central banks regulate the supply of money, which directly effects the cost to borrow it. Lower interest rates incentivize borrowers to take on debt and consume while dis-incentivizing savings.
Regrettably, a growing consequence of favoring lower than normal interest rates for prolonged periods is that consumers, companies, and nations grow increasingly indebted as a percentage of their respective income. In many cases, consumption is pulled from the future to the present day. Accordingly, less consumption is needed in the future and a larger portion of income and wealth must be devoted to servicing the accumulated debt as opposed to productive ventures which would otherwise generate income to help pay off the debt.
Today, interest rates are at historically low levels around the globe. Interest rates are negative in Japan and throughout much of Europe. In this article, we expound on the themes laid out in Negative is the New Subprime, to discuss the mechanics of negative-yielding debt as well as the current mindset of investors that invest in negative-yielding debt.
Is invest the right word in describing an asset that when held to maturity guarantees a loss of capital?
Negative Yield Mechanics
Negative yields are not only bestowed upon sovereign debt, as investment grade and even some junk-rated debt in Europe now carry negative yields. Even stranger, Market Watch just wrote about a Danish bank offering consumers’ negative interest rate mortgages (LINK).
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Peak Hubris
Peak Hubris
In the past month, two well-known and highly respected money managers have made confident assertions about the markets. Their comments would lead one to believe that the future path of the market in the coming months is known. Sadly, many investors put blind faith in the words of high-profile, accomplished professionals and do little homework of their own. While we certainly respect the background, knowledge, and success of these and many other professionals, we take exception with their latest bit of advice.
Before the election In November 2016, were there investment professionals that claimed a Donald Trump victory would drive equity prices significantly higher? Although we are certain there were a (very) few, they certainly were not publicly discussing it, and the broad consensus was overwhelmingly negative. In March of 2009, which professional investors were pounding the table claiming that the next decade would produce some of the greatest market returns in history? Again, while some may have thought valuations were fair at the time, few if any were raging bulls.
The two instances are not unique. More often than not, investor expectations fail to accurately anticipate the future reality. This is not solely about amateur individual investors, as it equally applies to the best and brightest. Despite the urge to heed the sage advice of the “pros”, we must always remain objective, especially when everyone seems so certain about what will happen next.
The Known Future
The current message from Wall Street analysts, media gurus and most investors is that stock prices will undoubtedly go up for the foreseeable future. Unbridled optimism about corporate earnings offer one point of fundamental justification for such views, but in large part these forecasts are predominantly based on the simple extrapolation of prior price trends.
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