Published October 5th, 2017
This is a guest contribution by Anthony Goff. Anthony Goff is a Financial Advisor (New-York-based) and loves sharing his opinions and vision to people who are interested in improving their financial status (and who isn’t?). He is also the founder of Personal Finance Hub, a place with appealing, straightforward articles about loans, debts, credits and other financial situations you might bump into.
After the 2008 Great Financial Crisis, policymakers adopted financial engineering in an attempt to restore the global economy. They have implemented policies such as Quantitative Easing and Zero Interest Rates which were meant to promote spending and lending.
The policies never seemed to work though, and after so many years, some European countries and Japan have come up with the Negative Interest Rate Policy (NIRP). But what does this mean to you as a stock and bond investor?
Nine central banks in large countries have already introduced negative rates as part of their plan to promote economic growth. By charging banks for depositing cash with them, they hope to persuade them to lend more money to the customers consequently spurring growth and investments. As the borrowing rates reduce, consumers will tend to buy more stuff since the alternative is being charged high fees for keeping money in an account.
The purpose of the negative interest rates is to discourage people from hoarding cash. But it is also expected to have an impact on spending behavior. For example, you may not want to use credit cards anymore. Instead, a charge card is going to help you control your spending habits since you will have to pay on a monthly basis. Experts also fear that negative deposit rates might make customers pull out their cash from banks that charge costly fees and resort to storing money under their mattress, which is free.
Why Investors Are Buying Negative Yield Bonds
For any rational human being, negative yield sound crazy and illogical. In the banking sector context, having negative rates would mean that the depositor will have to pay the bank for keeping their cash. If the rates were set at -1% for example, investing $1000 would leave you with $990 when the year ends.
In the same vein, if a bond is offering a negative yield, you won’t get the total amount of money you invested at maturity. In fact, you will have less than you did. For example, the German, one-year government bond has a -0.5% yield. Buying the bond will make you lose money at maturity.
On the face of it, the negative rates sound like a terrible idea until you realize that many investors are lining up to buy the negative-yielding debts in countries such as Germany, Japan and Denmark. There are two instances where subzero rates would look attractive to an investor.
- First, if the investor is risk averse and is afraid of losing money invested in risky assets, he/she will naturally chase after the “riskless” investments such as government bonds. They will not mind the low returns because the alternative would have been worse. Little money is better than none.
- Secondly, in a deflationary country, it is still possible to get positive returns with negative deposit rates. For example, if the deposit rates stand at -1% and inflation at -2%, the investor still makes a return of 1%. Thanks to deflation, the investor still makes money in spite of the negative interest rates.
Effects On Stocks
In the same manner that raising interest rates affects dividend stocks, negative rates are also expected to affect dividend stocks in their unique way. The introduction of negative rates is supposed to encourage banks to lend more thus pumping more dollars into the economy.
However, this is far from reality. Negative rates tend to spook markets. They are a sign that there’s something wrong with the economy. Each country that has adopted negative rates, save Denmark, has experienced markets falling. For example, the Nikkei fell by 6% in Japan after the country slashed its interest rates.
There’s an upside though. Although most markets may tend to react on the downside, some equities are likely to benefit. REITs and utilities, which are already favorites among yield-seeking investors, may perform best mainly because they have long-duration cash flows. Lower market rates make equities look more attractive from when you look at it from a valuation point of view.
How to Protect Your Wealth from the Negative Interest Rates
1. Buying Gold
According to World Gold Council, bond investors should expect to get little returns if any from their sovereign bonds as a result of the negative interest rates. It is likely to have a huge implication since bonds are usually go-to for wealth builders seeking to mitigate the risks of stocks. It is expected that the investors’ demand for equities will diminish due to the uncertainties occasioned by the NIRP. Bonds will no longer be a safe haven either.
The investor is not left with that many choices as far as protecting his wealth is concerned. The next obvious option available is gold. According to the WGC, the current circumstances seem to favor the demand for gold because central banks have been accelerating the buying of gold after the financial crisis in 2008. In the second half of 2015, central banks bought 336 tons of gold. This is a staggering amount and is a reflection of the countries’ intention to diversify their foreign reserves. Data coming from WGC points to the surging demand for the gold bar and coin in developed markets.
2. Buy Stocks that will Grow
Another way of surviving the negative interest rates is to buy stocks that are expected to increase as the economy grows. If the central bank hopes to revive the economy, it might be advisable to buy a technological stock. A lot pay dividends nowadays. Not only will you get yields that you wouldn’t normally get in a savings account, but corporate growth will also work in your favor. You need to work with companies that can survive slow economic conditions and grow in pleasant ones.
3. Managed Futures
Managed futures are relevant for two reasons.
- Its unique ability to make profits even when the market seems volatile gives it a unique advantage of having a negative correlation to stocks when markets are not favorable and a positive correlation when the markets are quite promising.
- Managed futures have also effectively captured price trends in raw materials like precious metals and crude oil, sources of return that have no relation to stock or bond markets.
Many investors are holding on to their money and preparing to invest in the stock market. Such wealth builders should consider the implications the negative interest rates are likely to have and add some little diversity in their portfolios. In this day and age, cash is losing its superiority. Keeping it in the bank is not a viable option since it will be eroded slowly as each day passes. Take action today and protect your hard-earned money before you lose it all.