by Scott Ronalds
I don’t know why, but I’ve been listening to a lot of Dire Straits lately. “Sultans of Swing” never gets old. “Walk of Life” is a beauty. But it’s the guitar lick in the 80’s hit “Money for Nothing” that’s become the band’s signature (admit it, you can’t help but play the air guitar when you hear it).
I never really listened to the lyrics of the song (Money for Nothing) until recently. Turns out, the tune’s about a guy working in the hardware department of an appliance store who's watching MTV and commenting on what he’s seeing. Deep stuff.
Another thing I didn’t know is that the lyrics are homophobic at times and have sparked controversy. According to Wikipedia, the Canadian Broadcast Standards Council (CBSC) ruled in 2011 that the unedited version of the song was unacceptable for play on Canadian radio stations. The Council later changed its decision, allowing stations to decide whether to play the edited or unedited version.
But make no mistake, the notion of money for nothing remains controversial well beyond the Dire Straits tune. The cost of borrowing is next to nothing in many countries around the world. And interest rates are in fact negative in most parts of Europe. There’s a headline making the rounds that in Denmark, you can get a 10-year mortgage for -0.5%. That’s right, the bank pays you. (In reality, the impact of banking fees could mean that you still owe money on the loan.)
Remarkably, there are only five major bond markets in the world now without negative rates: USA, Canada, UK, Australia and New Zealand. But cheap money does not come without risks and there are heated debates on the topic taking place. (Tom Bradley elaborates on this ‘macro mayhem’ in his latest Financial Post article). Below is a rundown of some of the pros and cons.
A key argument for ultra-low (or negative) rates is that they encourage businesses to borrow money to enhance/expand their operations and, in turn, grow the economy. They also incent individuals to buy more goods and services, which also helps fuel the economy. Another benefit is that stocks and real estate prices are typically buoyed in a low interest rate environment, as lower-risk assets offer very little return.
The flipside of low/negative rates is that it becomes more difficult for banks and the financial system in general to operate efficiently. As well, savers are essentially punished by earning very little interest on their deposits, GIC’s, and bonds. Further, low rates can backfire if they lead to people and businesses hoarding cash in fear/anticipation that consumer prices will drop (deflation). And importantly, when borrowing costs are near zero, central banks lose an important tool to help combat slower growth or a recession — the ability to lower interest rates.
Making sense of it all
We’re living this debate real-time and it can be difficult to make sense of it all. The U.S. Federal Reserve cut its key interest rate by 0.25% last week for the second time this year, yet some policymakers thought it was unnecessary while others felt it wasn’t enough. President Trump, for one, criticized Jerome Powell (the Chair of the U.S. Federal Reserve) for not cutting rates to zero or less, noting that Powell has “no guts, no sense, no vision”. The debate and controversy will rage on.
If you’re wondering whether you should be making any changes to your portfolio given the uncertainty around interest rates and the latest moves by central banks, remember that it’s never wise to make wholesale shifts without good reason. Low, or even negative rates, do not constitute good reason. Fixed-income investments should still have a place in your portfolio for their safety and low correlation to stocks, even in such an unclear rate environment.
It's not advisable to make big adjustments to your stock exposure either. Consider Warren Buffett’s response when asked a few years ago by The Street how he considers the Fed’s decisions in his investment process: “I’ve never bought or sold a company where what the Fed is doing, or is likely to do, has entered into my calculation ... not in 50 years, and it never will.”
Unfortunately, perhaps the only certainty in times of rock bottom rates is that retirees and other income-focused investors are put in a difficult situation and will be challenged to earn decent returns. To be sure, this is not an era of juicy real yields (after inflation) like decades back.
I want my MTV.
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