Market Buzz – It isn’t a secret to anyone paying attention that we have been frolicking in a historically low interest rate environment since 2009. Low interest rates are a natural occurrence during times of economic distress as capital tends to flow into the government bond market which is viewed as a safe haven for investors looking to wait out the storm. Central banks (aka U.S. Federal Reserve) also engage in stimulus initiatives aimed at keeping interest rates low to encourage borrowing, spending and economic development. When the economy starts to turn the corner, interest rates begin to rise as capital flows out of the bond market and governments ease off on stimulus.
With the general consensus supporting a gradual improvement of the U.S. and global economies, forecasters a many have been throwing in their two-bit conclusions on when we should start to see interest rates rise back to (or at least close to) historical levels. Not in recent memory was the voice of these pundits so strong as in June of last year when a sudden spike in rates had the herd calling the “turn of the corner” on interest rates and for 4% plus yields on the 10-year bond by the second half the following year (right about now). But as the old adage goes…”the loudest ship is usually empty.” The 10-year yield did increase over 50% from a historic low of 1.72% in April 2013 to 2.63% only 4 months later causing calamity for interest rate sensitive stocks (particularly dividend stocks and REITs), but then ever so quickly tapering off and more recently continuing its descent downward. As of Friday, the 10-year yield was 2.26% or close to the lowest it has been since May of 2013.
The markets on the other hand have never been happier…literally. As of the close on Friday, the TSX Composite and the S&P 500 continue to hover at historic highs. Stocks tend to benefit from low interest rate environments. On one hand, low interest rates make it easy to borrow capital cheaply. On the other hand, investors are more willing to bid up valuations on stocks as they can’t generate a reasonable return in the bond market. But in spite of what appears to be euphoria in the stock market, low interest rates to not insinuate a rosy outlook for economic growth….quite the opposite actually. Generally speaking, an analysis of short and long-term bond yields (illustrated by something called the yield curve) currently indicates that the outlook for economic growth is in fact bleak.
Thankfully at KeyStone, we think it is a bit of waste of time to focus too much on “he said, she said” with the stock and the bond markets. At this point (or at any point for that matter), it is pretty much impossible to say if the stock market will be correct, the bond market will be correct, or if they will somehow agree to meet in the middle. An investor could literally drive themselves nuts trying to analyze the ins and outs of macroeconomics. Focusing on individual companies and their individual fundamentals proves to be much easier and more effective.
So what is an investor to do in these unusual markets? First off, don’t listen to opinionated forecasters. Most of them just try to extrapolate the current trend. The stronger the opinion someone has on their forecast; the weaker the forecast (generally speaking). Secondly, follow this advice:
1. Stick to profitable, cash flow generating businesses that can be purchased at reasonable valuations (remember that the antonym of reasonable is unreasonable).
2. Try to avoid companies with too much debt (they won’t do well when interest rates do rise).
3. Maintain a strategy of focused diversification (8 to 12 stock portfolio).
4. Keep some cash on the sidelines for when good opportunities arrive (anywhere from 10% to as much as 50%).
5. Don’t speculate (save that for Vegas).
6. Don’t trade aggressively (target a minimum time horizon of 1 to 3 years on stocks).
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