Zero Interest Rates – Disaster or Blessing?
It is hard to imagine it has only been seven years since the depths of the global financial crisis. The recovery in developed economies has been painfully slow. The central banks of these major economies have adopted unconventional monetary policies to kick start their economies. Yet, seven years later, while unemployment has largely stabilised and asset prices have mostly recovered beyond their pre-financial crisis days, we find interest rates at unprecendented low levels, some even falling below zero. This policy choice by central banks will have consequences at some stage down the road with some countries likely to suffer more than others.
Asset prices are often valued against the “risk-free” rate to come to some sort of estimated valuation. However, when the so-called risk-free rate is at or close to zero, or worse still, at a negative, how does one use these measures to effectively and accurately value assets? Should assets be much higher than where they are now if rates are at zero, or does this current policy present even greater risk? Should asset prices be priced at an even higher presumed rate than historical averages to account for these unprecedented times? The answer, no doubt, is somewhere within this very large range.
As many nations get used to a “lower for longer” interest rate scenario, we examine possible consequences of what these sorts of unconventional policy decisions can do for the economy and what zero interest rates mean for investors and consumers.
Our view
Central banks use the blunt monetary policy tool (i.e. interest rates) to boost their economic growth. However, the ongoing use of this tool to suppress interest rates is an indication to us that providing cheap money in a seemingly endless fashion is a glaring signal that all is not well in the economic world.
Without trying to make things too simple, the most honest opinion we could provide you is that it is hard out there and we do not know what lies ahead. While there is always a level of complexity with understanding economics, this time around, it really is different. So if the professionals find it hard to fully grasp the extent of what unconventional policies can do, what chance do the typical investors have against this sort of economic backdrop?
Successful investors need to always be adept at finding opportunities that are capable of producing favourable returns over time on the capital. A true investor simply looks to achieve above-average returns through buying assets for less than they are worth. This concept is simple but it is not easy to execute. The difficulty of course is that the intrinsic value of an asset (such as a company) is not easily observable. We must differentiate this with the share price, which is observable at any time, but may not reflect the value of the company. Rather, a firm’s intrinsic value is usually derived from the cash flows the firm is likely to produce over its lifetime.
The wonderful thing about investing is that our advice and philosophy will not change whether interest rates are at zero or at twenty percent. Both extremes have their unique challenges, but at the end of the day, the methodology of how an asset should be valued will remain the same. In these times, it is even more important to be guided through the ever complex policy-driven market. On the other hand, these depressed yields mean that investors have had very little choice but to increase the risk of their portfolios to try and hit longer term objectives. This flight of liquidity to riskier assets has pushed valuations higher driven by these inflows. We think this is unsustainable and we have no doubt that some significant volatility in markets is likely to come some time down the road. The question is when?
With this backdrop, we continue to remain cautious when investing.
New Year – Fund Launch
In the first quarter of the New Year, we are excited to be launching a diversified fund that has been designed with our clients’ best interests and financial future in mind. With the investment landscape seemingly becoming more difficult with such unconventional macro-economic policies being pursued, we want to make sure that our clients always have an up to date portfolio that is set up for the current climate whether you see us only once a year or more often than that. We have teamed up with some of Australia’s and the world’s premier firms to develop an investment product that is able to adapt to the ever changing economic landscape by focusing on what is important to produce solid long term returns.
Our advisers will no doubt be discussing and seeking your approval in the coming months to manage all or the core of your portfolio in this manner.
Disclaimer: This publication has been compiled by Financial Decisions (AFSL/ACL Number 341678). Past performance is not a reliable indicator of future performance. While every effort has been taken to ensure that the assumptions on which the outlooks given in this publication are based on reasonable data, the outlooks may be based on incorrect assumptions or may not take into account known or unknown risk and uncertainties. Material contained in this publication is an overview or summary only and it should not be considered a comprehensive statement on any matter nor relied upon as such. The information and any advice in this publication do not take into account your personal objectives, financial situation or needs. Therefore you should consider its appropriateness having regard to these factors before acting on it. While the information contained in this publication is based on information obtained from sources believed to be reliable, it has not been independently verified. To the maximum extent permitted by law: (a) no guarantee, representation or warranty is given that any information or advice in this publication is complete, accurate, up-to-date or fit for any purpose; and (b) Financial Decisions nor its employees are in any way liable to you (including for negligence) in respect of any reliance upon such information or advice. October 2016
Contact: Financial Decisions PO Box 484 Mona Vale NSW 1660, T 02 9997 4647, F 02 9997 7407