A Safety-First Approach for "Uncharted Waters"

08/27/2019 5:00 am EST

Focus: MARKETS

James Stack

Founder, InvesTech Research

In a “normal” cycle, consistent economic growth leads to gradually increasing inflationary pressures and a corresponding upward move in interest rates, explains Jim Stack, a leading money manager — known for his safety-first strategy — market historian and editor of InvesTech Research.

However, this cycle has seen numerous instances of stalling growth and rolling movements in interest rates largely due to central bank intervention. The net result is global rates have actually declined over the course of the last ten years.

The question is: Has this economic cycle been driven by demand for goods and services or just aggressive central bank policy and rising debt levels? Said differently, have the actions of central banks around the globe created an economy addicted to leverage?

As interest rates of major global economies have turned negative for the first time in recorded history, we feel the answer could have dire long-term consequences.

Since the Great Recession of 2008, a barrage of unique and aggressive monetary actions have been utilized in an attempt to spur investment and prop up global demand.

These actions have included quantitative easing (QE), zero interest-rate policy (ZIRP), and now a whole new era of something called negative interest-rate policy (NIRP). Typically, when a lender provides a loan, they require repayment of the full amount in addition to a specific rate of interest based on a myriad of risk factors.

Negative interest rates flip this relationship upside down as it implies that lenders pay an individual or a business to borrow money from them.

While the intent is to encourage consumers to borrow, thus spurring economic growth, there can also be numerous unintended consequences.

More and more countries are seeing their interest rates fall below zero as global negative yielding debt is now in excess of $15 trillion. The truth is, no one knows the long-term effects of a negative interest rate environment.

However, the ever-increasing central bank intervention raises the risk of capital misallocation and financial bubbles. Additionally, central banks have little ammunition left to cushion the next downturn.

At face value, this sounds like a great idea to anyone who has ever owned a home, but the risks far outweigh the benefits. Offerings such as this put the viability of banks in question, along with the overall economy.

Ultimately, no one knows the consequences of today’s negative bond yields. We are in uncharted global waters, and this time the U.S. economy may not be immune to the fallout.

While Federal Reserve rate cuts are intended to be stimulative (expect another one in mid-September), the past two recessions proved how little control the Fed actually has over the economy and stock market when already on a collision course.

We clearly have adequate evidence to continue steering a more cautious course as we adhere to our safety-first investment strategy. And we will take more decisive steps to increase defenses if/when confirmation flags of a bear market and recession appear.

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