One side-effect of low interest rates is that it’s easy for investors and savers to feel paralysed.
What’s the point on trying to make any money amid all this financial repression? There are too many risks and not enough rewards.
So this morning, I want to take a look more closely at where investors might be able to make some money in these markets…
Low interest rates are self-defeating
I’ve said for a long time – mainly in reference to Japan – that ultra-low interest rates are potentially self-defeating.
Low rates are meant to encourage people to take risks, by forcing them out of “safe” assets.
But the problem is that, psychologically speaking, low rates also create an environment where investing looks extremely risky. And that’s very off-putting, particularly for investors who are already primed to be risk-averse.
We already know that human beings aren’t the narrowly “rational” economic actors that economic models assume them to be. We have all manner of psychological tics that are and were helpful in terms of survival, but are not necessarily helpful for analysing investments.
For example, we “anchor” our expectations – we struggle to divorce present day circumstances from historical experience, even that historical information is not actually relevant.
(Simple example – if you buy a share for £1, and the company loses a huge customer and falls in value to 50p, then you won’t be able to get the idea that it’s still worth £1 out of your head, even although the new circumstances mean that the historical price is now entirely irrelevant).
We all have a rough idea in our heads – shaped by our experience – of the sorts of levels of return we “should” be getting from a bank account, or the sort of price that a house “should” cost, or the level of expected return that we “should” get from a bargain investment.
Low interest rates disrupt all of that. If you expect to get a 4% nominal interest rate from a bank account, say, then anything lower than that looks paltry.
(Forget about “real” interest rates, incidentally – as Professor Robert Shiller pointed out the other day at a Barclays seminar I attended, no “normal” person instinctively thinks about post-inflation interest rates, and indeed, economists only began considering them in the late 1800s.)
And if 4% is what you expect to get from a “risk-free” deposit account, then you expect to get a lot more from a stockmarket investment or a corporate bond fund.
So if that’s not what’s on offer, then it doesn’t feel very tempting to take the risk. If you keep expecting rates to go up at any moment, then investing in anything at current levels feels like “picking up nickels in front of a steamroller’, as the old adage about carry trades goes.
In other words, financial repression suffocates “animal spirits” in as much as confidence alone has an effect on investment in the wider economy.
Where can you invest right now?
But that doesn’t mean that there aren’t opportunities out there. So where should investors be looking just now?
I was taking a look through a research piece by David Rosenberg of Gluskin Sheff over the weekend. I have more time for Rosenberg than for most analysts – he’s sceptical without being perma-bearish – and I thought his views were worth sharing.
In common with quite a few other sharp analysts, he reckons that “commodities and gold may very well have the best five-year horizons right now, for those few who are patient investors.” The good news is that if you are managing your own money, you can afford to be a patient investor. We wrote about some of the best gold plays in MoneyWeek magazine recently – if you’re not already a subscriber, you can sign up here.
As far as stocks go, one of Rosenberg’s top sectoral themes is defence – pretty much regardless of who wins the US election, the state of the world is such that (unfortunately) rising defence spending seems inevitable. On a slightly more positive note, infrastructure companies may do well too as the world’s governments start to swivel towards boosting their spending.
As for international markets (Rosenberg writes from Canada with an inevitable US focus), he likes Brazil, India and Japan. I’d agree on India and Japan for the long term.
As for Brazil – we’ve been keen on Brazil in MoneyWeek magazine since the start of this year, when it was being battered into submission by the commodity rout and political uproar, and as Mebane Faber of Cambria Investment Management put it, it was “the cheapest country in the world”.
It’s rallied so far and so fast (up more than 60% this year, last time I looked) that I’d be instinctively wary of adding more exposure, but I wouldn’t want to sell either.
These are by no means the only places to invest. My colleague Tim Price has been writing about financial repression for longer than pretty much anyone I know. He’s also one of the most bearish commentators I know. Yet Tim’s portfolio is by no means all cash and precious metals – he also has plenty of views on which markets and asset classes offer the best returns right now.
You can read Tim’s views in his London Investment Alert newsletter – you can find out more about it here.