Central banks around the world, including here in the US, are still sore from the aftermath of the banking collapse in 2009 and are doing everything they can to prevent their economies from stagnating.
To counter economic slowdowns, central banks rely on tools such as their ability to influence interest rates. The theory is that by lowering interest rates, central banks make it easier and more financially attractive for corporations, governments, and individuals to borrow more and spend their loans on investments and business purchases, such as homes, appliances, and automobiles, to keep factories running. increase employment and stimulate the economy in a benevolent booster cycle.
In the US, our central bank, the Federal Reserve, controls interest rates through something called the Federal Funds Rate, which ultimately affects the rate on all commercial, municipal, and individual loans, and affects the interest we earn, on our investments in CDs, savings accounts and bonds, and paying off credit cards, our mortgages, etc.
I won’t go into too much detail, but the Federal Reserve changes the fed funds rate in steps of 25 basis points or quarter percentage points, and right now, this rate is at 0.25%, one more step down and it will continue drop to zero, which the Fed would never do. So a 0.25% rate is the lowest possible and the Fed has hinted almost unambiguously that it plans to leave rates at this record low for at least a few more quarters.
Now, more recently, central bank fears have flared again due to election results in places like France and Greece, where citizens have voted for candidates who oppose much-needed austerity measures and reforms to rebalance national economies. . The election results in Greece, for example, have renewed fears of a complete collapse of the Greek economy, which will have repercussions throughout Europe and the rest of the world in today’s increasingly interconnected global market… psychologically it makes the dollar a safer place to park your money relative to other currencies.
Therefore, most central bankers have no desire to raise interest rates.
The downside of this for income-seeking investors is, as I said before, that the rates they receive on CDs and such are way below inflation. For example, according to BankRate.com, the best rate on a 1-year CD right now is 1.15% and the average rate is just 0.70%. You can invest in safe US Treasuries, but the best rate you’ll get is even lower: just 0.19% for a 1-year Treasury bill and just 1.98% for a Treasury bill to 10 years. Compare that to 2.7% inflation each year and you’ll know that your investments in CDs or bonds just aren’t going to cut it. You clearly need to earn more.
While that’s your downside as an individual, your upside is that things like mortgage rates are currently at record lows (3.84% for a 30-year fixed-rate mortgage), making this a great time to borrow. .
And while people limit their loans to what they need, corporations and municipalities, especially those with strong balance sheets and good credit histories, are having fun…because credit has rarely been so cheap. For example, the Financial Times recently reported that IBM sold $600 million of 7-year debt at an all-time low interest rate of just 1.875%. IBM went a step further and also issued $900 million in three-year 0.75% notes. Other strong companies, like Warren Buffett’s Berkshire Hathaway, also know they may never see interest rates this low again and issue billions in debt. And despite these low interest rate returns, IBM and Berkshire had no problem finding buyers for their debt because buyers at home and abroad also see our dollar as a safe-haven currency while world economies are unstable.
So what’s an individual investor to do to earn a decent return that beats inflation and then some?
The answer, fortunately, is quite simple. Invest in strong companies that are benefiting from this low interest rate environment. You see, when IBM borrows money at low rates, its interest expense goes down considerably, its earnings go up, and its stock does well. So instead of buying debt like IBM and earning measly rates like CDs, buy their stock. And buy stocks that pay dividends and outperform inflation.
And as I’ve often said, while the world is in trouble, the US economy seems to be more stable than the rest and US companies are at the forefront of growth in places like China and India. So someone like IBM can take their low-cost money and expand their competition in emerging markets or invest in better infrastructure, and thus set themselves up for better long-term success and profits where, over time, their rate of return will exceed to government bonds. and other fixed income investments. And just to clarify, I’m not recommending IBM but just using it as an example.
So don’t load, do your research and see market declines as opportunities to buy strong companies at reasonable prices to generate returns that outpace inflation.