Ordinary Investors Now Have an Advantage Over the Pros
Pigs still can’t fly and hell hasn’t frozen over, but interest rates have gone negative, and that’s weird enough. In early March, about a quarter of the debt issued by euro zone governments traded with negative yields. On March 9, six-month Germany Treasury bills—Unverzinsliche Schatzanweisungen—were auctioned to yield an annual rate of –0.22 percent. This means that if you buy a German bill and hold it to maturity, you won’t get all your money back. And Germany is having no trouble finding investors willing to accept those terms.
Keep those Unverzinsliche Schatzanweisungen in mind as you look for ways to make money. Whether it’s oil futures or oil paintings, each investment opportunity competes with other investment opportunities. When the German government gets away with paying negative interest, it’s a sign that investors don’t think they have better options. If they did, they would be putting their money into them. After a long, strong rally in the major world markets, it’s time to lower your expectations for growth.
On the bright side, individuals have a big advantage over the pros at a time like this: They don’t need to put up with negative rates, because they don’t have millions of dollars in need of short-term safekeeping. And they don’t have to report their results quarterly, so they can tune out the din of conflicting advice and focus on the long run. While the pros worry that healthy economic growth will hurt stocks in the short run by encouraging the Federal Reserve to raise interest rates, ordinary investors can hope that growth will result in more jobs, increased spending, higher corporate profits—and higher stock prices.
Easy money from the Fed and other central banks has been rocket fuel for stocks and bonds. An investment in the Standard & Poor’s 500-stock index has returned almost 23 percent a year since the low of March 9, 2009, including reinvested dividends. “That’s stupendous,” says Michael Hartnett, chief investment strategist for Bank of America Merrill Lynch Global Research. “It cannot continue indefinitely.”
Markets are on edge as Fed policy-makers deliberate over when to start raising the federal funds rate, which has been at 0 to 0.25 percent since December 2008. “I’m still a longer-term bull, but this year is going to be volatile,” says James Paulsen, chief investment strategist for Wells Capital Management. “We might well have a 10 percent to 15 percent correction in U.S. stocks.” To Paulsen, one little-noted warning sign is that the median price-earnings ratio for U.S. stocks set a record last year—and is probably higher now (chart). He views the median p-e as a better valuation measure than the more commonly cited capitalization-weighted p-e, which is heavily influenced by the price movements of the biggest companies.
Stocks could survive higher interest rates if brisk economic growth boosts earnings. Sharmin Mossavar-Rahmani, chief investment officer for Goldman Sachs’s Investment Strategy Group, says tightening by the Federal Reserve doesn’t always lead to a recession, and even when it does, stocks rise for an average of 18 months after the tightening begins. Stocks do really well before it begins (like now). “Over the past six tightening periods since 1980, the S&P 500 has returned 23.5 percent on average in the nine months prior to the first rate increase,” Scott Minerd, global chief investment officer for Guggenheim Partners, wrote in February.
“We think the cycle does have some time to run,” agrees Russ Koesterich, chief investment strategist at BlackRock, the world’s largest asset manager. He says the most vulnerable parts of the market are hot sectors such as biotech and social media, and safe “bond substitutes” such as utility companies and real estate investment trusts. “What’s more reasonable is what’s in the middle,” he says—namely sectors that benefit from stronger economic growth, such as consumer goods and finance.
Those 23 percent annual returns are most likely a thing of the past, but there’s still some upside left in the markets. Just be glad your little fortune isn’t tied up in Unverzinsliche Schatzanweisungen.