In the last 5,000 years there has not been an instance of negative interest rates – until now. At present, there is almost $12 trillion invested in negative-yield government bonds issued by Japan, France, Germany and other countries (1). At one point during the quarter, investors were effectively paying the Swiss government to hold their money over a 50-year time horizon.
Why is this happening? The game-plan of central banks for the past seven-plus years has been to prop up asset prices (stocks, bonds, real estate) by keeping interest rates low. The resulting “wealth effect” was supposed to spur demand and ultimately the robust economic growth that has yet to materialize. Central banks have doubled down by pushing rates to the lowest point since, well, ancient Mesopotamia.
There is potentially an even more insidious aspect of government policy. In recent years, some central banks have quietly “diversified” their bloated balance sheets by buying stocks as well as bonds. SEC filings reveal that as of June 30, the relatively tiny Swiss National Bank owned $1 billion or more of Apple, Google, Exxon, Johnson & Johnson and Microsoft. The Bank of Japan is now a top-10 shareholder in about 90% of the Nikkei 225 (2).
And then there’s the debt, which the IMF recently recognized as “a risk to financial stability”. The $152 trillion world debt pile is now 225% of world gross domestic product (3). We have stopped counting the use of the word “unprecedented” to describe the current state of affairs.
We believe this highly combustible concoction of low rates, large-scale stock buying and mounting debt will exert upward pressure on stock prices as long as these conditions persist. In the short-run, our fundamentals-driven, cash-hoarding investment approach will most likely trail the seemingly obvious tactic of front-running the government. While the laws of economic reality cannot be permanently repealed, they can unfortunately be suspended longer than any of us would like.
We ask that you not confuse our holding and waiting for inattention. Many of the funds we use have appeared to just tread water over the last few years while the rest of the market has surged. What happens though when interest rates rise, central banks unwind their positions and deleveraging occurs? Though the value strategy has struggled as of late, our main priority remains navigating what could be a volatile future while still providing returns that will help you achieve your goals.
Aaron Pettersen, CFA, CFP®
1. Borin, Matthew. James Grant: Negative Interest Rates Will End - Badly. Seeking Alpha. 08 09, 2016.
2. Nakamura, Yuji. The Tokyo Whale is Quietly Buying Up Huge Stakes in Japan Inc. Bloomberg.com. 04 25, 2016.
3. Mayeda, Andrew. The IMF is Worried About the World's $152 Trillion Debt Pile. Bloomberg.com. 10 05, 2016.