Investing and the 800-Pound Gorilla – Future Interest Rates
In late 2008 and early 2009 investors did not know how to invest to make money. There appeared to be no good investing strategies, only a place to hide. The lucky folks hid in cash equivalents (cash) like T-bills and money market funds, or in savings products like CD’s and savings bonds. Interest rates were at historial lows. Hiding in cash was not a good way to make money, but at the minimum you didn’t lose money.
Picture a conference room complete of investors trying to come up with investing strategies for how to invest to make money in such a financial ecosystem. The stock market was down 50%, bond yields were low, commodities prices were falling, and interest rates were at record lows.
Now picture ignoring the 800-pound gorilla in the room, the possibility that interest rates could rise in the not-too-distant future. In devising investing strategies and calculating how to invest, interest rate trends can not be ignored. For the past 40 years interest rates have affected stock prices, bond values, and rates in the money markets and at the bank.
Consider these numbers for early 2009: federal funds rate near 0%, 1-year CD’s at about 1%, money market funds at .25%, and 30-year mortgages below 5%. How much lower can rates go before they turn around and head back up?
In deciding how to invest, the 800-pound gorilla really wants to know,”what happens when interest rates go up”? Here is what I have seen happen in the past, since I started in the investment business in 1972. When interest rates went up…
STOCK PRICES fell. Higher interest rates increase corporate borrowing costs. Sales fall as consumers who buy on credit pull back on spending. Lower sales and higher costs translate to lower corporate profits and lower stock prices. Stock investors did not make money, they lost it.
BOND PRICES fell. As interest rates rise, existing bonds with lower coupon interest rates become less attractive. Investors bid bond prices down to bring yields up to prevailing rates. Bond investors did not make money, they lost it in addition.
CASH (equivalents) and SAVINGS PRODUCTS paid higher rates. Cash, as they say in the business, was king. When interest rates go up rates on CD’s, T-bills, savings accounts, and money market funds follow suit. So do rates for credit cards, mortgages, and other loans. Investors here did make money in the form of higher interest, and they avoided heavy losses.
Since 2 out of 3 of our investment areas were losers in the past when interest rates went up considerably, it might appear that the only sensible investing strategy when rates are rising is to be 100% in cash or savings products. In the past, smart investors in search of how to invest to really make money have looked outside the box of stocks and bonds…to different investments.
different INVESTMENTS in my mind’s eye includes foreign securities, oil, gas, gold, silver, real estate, basic materials like copper and aluminum, and other tangibles.
How can the average investor participate in these markets? Using oil as an example, you do not want to go out and buy barrels of oil or gasoline if you think oil prices will rise. Buying futures contracts on crude oil is not a appropriate investing strategy for most folks, either. If you have a brokerage account and know how to invest, you can buy oil stocks or oil ETF’s (exchange traded funds).
Or you could participate and make money as oil prices rise the easy way. Simply invest in a specialty mutual fund, an energy fund that holds oil stocks. There are also mutual funds that specialize in gold stocks, foreign stocks, real estate stocks, and so on.