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Searching for Yield? Better to Look for Humility and Patience

The following is an excerpt from Investment Management Associates’ second-quarter letter to investors.

The Great Recession may be over, but seven years later we can still see the deep scars and unhealed wounds it left on the global economy. In an attempt to prevent an unpleasant revisit to the Stone Age, global governments have bailed out banks and the private sector. These bailouts and subsequent stimuli swelled global government debt, which jumped 75 percent, from $33 trillion in 2007 to $58 trillion in 2014. (These numbers, from McKinsey & Co., are the latest we have, but we promise you they have not shrunk since.)

A lot of things about today’s environment don’t fit neatly into economic theory. Ballooning government debt should have brought higher — much higher — interest rates. But central banks bought the bonds of their respective governments and corporations, driving interest rates down to the point at which a quarter of global government debt now “pays” negative interest.

The concept of positive interest rates is straightforward. You take your savings, which you amass by forgoing current consumption — not buying a newer car or making fewer trips to fancy restaurants — and lend them to someone. In exchange for your sacrifice, you receive interest payments.

With negative interest rates, something very different happens: You lend $100 to your neighbor. A year later the neighbor knocks on your door and, with a smile on his face, repays that $100 loan by writing you a check for $95. You had to pay him $5 for forgoing your consumption of $100 for a year! Try to explain this logic to your kids. We tried to explain it to ours and failed, miserably.

The key takeaway is this: Negative and near-zero interest rates show central banks’ desperation to avoid deflation. More important, they highlight the bleak state of the global economy.

In theory, low and negative interest rates were supposed to reduce savings, get consumers off their butts and stimulate spending. In practice, the opposite has happened: The savings rate has gone up. As interest rates on their deposits declined, consumers felt that now they had to save more to earn the same income. Go figure.

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Vitaliy Katsenelson

I am the CEO at IMA, which is anything but your average investment firm. (Why? Get our company brochure here, or simply visit our website).

In a brief moment of senility, Forbes magazine called me “the new Benjamin Graham.”

I’ve written two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. (I’m working on a third - you can read a chapter from it, titled “The 6 Commandments of Value Investing” here).

And if you prefer listening, audio versions of my articles are published weekly at investor.fm.

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