PLUNGING INTEREST RATES
CAN HAVE A GOLDEN LINING
June 20, 2004 - A change in the psychology and actions of a large segment of the American population was severely altered when the Federal Reserve Board aggressively drove down short-term interest rates. For several years short- term rates on 90 day Treasury Bills were quite stable. They offered their holders annual rates of return above 4%, and occasionally exceeded 5%. In fact, 2000 witnessed these short rates rise above 6%. When that occurred, the lives of the investors who owned these and other short-term monetary instruments seemed certain to improve. This was due to their belief that the added income accruing from these investments would increase their purchasing capacity, and would allow them to experience an easy, more worry-free existence. They felt that they could lead a more comfortable life because their incomes had improved. Unfortunately, this mind-set was as short-lived as the fleeting +6% interest rates. For many, this brief period of contentment was soon replaced by the worst of all worlds.
A large and growing contingent of Americans live on fixed incomes. They are either retired or soon to be, and their primary source of income is largely generated from dividend or interest bearing accounts, or instruments whose rate of return is predicated upon the interest rate level. They may have savings accounts of one form or another, bonds or annuities, or one of a multitude of interest sensitive products. These individuals use the principle or interest generated by their investments to supplement their social security payments. Further, many of the throngs of baby boomers plan to shortly join their ranks, when they too will retire. Many individuals from this latter group are increasing their more stable investment type holdings as they near retirement, and their aversion to risk rises.
We all structure our lifestyles based upon the amount of income that we expect to receive on either a weekly, monthly, or annual basis. This is the sum of earnings from our employment, investments, various businesses, as well as our anticipated interest and dividend payments. When one approaches or reaches retirement, the primary source of their lifelong income, their salaries, is removed from their income equation. It may be replaced by social security or other retirement benefits, but seldom are these as great as the salaries that they will no longer receive. Further, retirees desire a greater sense of security because their income is limited and they must rely on their finite, life-time accumulated wealth. To this end they husband their assets in the best fashion that they can. This motivates many to shun equities and other forms of investments due to their great volatility, and the potential for losing their assets from falling market prices.
Due to the enormous population of baby boomers, our nation consists of an increasing number of families that are dependent upon the returns from their interest sensitive investments. If their income is stable, they will have one less thing about which to be concerned. To these people, fluctuating interest rates pose great risk. They have already planned their spending decisions around their new income, and can suffer great hardship if their income stream is impaired. This will occur when interest rates sharply fall.
Interest rates rose strongly in late1999, and peaked in 2000. When that occurred, 90 day Treasury Bills offered their owners an annual rates of return in the 6.50% range. This was significantly higher than the 4.50% to 5.50% rates that these instruments yielded for the prior several years. While it lasted, the more robust yields offered those who heavily relied upon their interest and dividend returns a ray of hope. They thought that this was the beginning of better times for them because they anticipated increased weekly or monthly interest payments. Unfortunately, from that fleeting high point interest rates in general, and short-term ones in particular, began to plummet.
In September, 1999, a Dow Theory Bear Market was signaled. Later, in January, 2000, the U.S. stock market as measured by the Dow Industrials peaked, and shortly thereafter the economy began to show signs of weakness. By the end of 2000, anecdotal evidence of an economic decline was already building. This was largely due to the earlier fiscal and monetary policies that the government and Fed had executed. These first fostered and then perpetuated, the unsustainably high standard of living that this nation enjoyed for decades. Recognizing the potential for a severe economic collapse created by this condition, Alan Greenspan understandably became quite concerned.
In the winter of 2000, Alan Greenspan's response to the falling stock market and weakening economy, was to abruptly force down interest rates. After all, whenever faced with a contracting economy, that was the same method that all earlier Federal Reserve chairmen used for the prior six decades. Greenspan knew that this action worked! By reducing interest rates, the Fed chairman similarly hoped to stimulate business and investment, to reverse the economic decline and soften the stock market's fall. Unfortunately, the declining interest rate environment wreaked havoc upon those who were accustomed to the higher and relatively stable interest rate levels of the past. These people became trapped, and were forced to live on a significantly smaller income.
Finally, when interest rates bottomed in the summer 2003, 90 day Treasury Bill rates were yielding below 1%. This placed thousands upon thousands of households in the precarious position of not knowing how they would continue the living standards to which they had become accustomed. Those who could earlier, comfortably survive solely on their dividend and interest payments, now had to use some of their principle. Others who were already also living off of their assets were forced to draw them down at a faster rate. In both instances, fear ran through those who were now forced to face the possibility that they might outlive their assets. Panic set in among many of these individuals.
Faced with the real fear of having to either sharply curtail their spending or to run out of assets and become destitute, many of these people entered the stock market in the hope of achieving a better return on their assets. These people joined others who faced a similar fate, but who began acting in this fashion when interest rates first entered their steep decline. The last individuals who succumbed and moved their assets into equities, would have earlier shunned the idea of taking greater risk to maintain their living standards. They now felt desperate, and compelled to at least entertain the prospect.
Most individuals who invest in interest bearing instruments are conservative by nature. Prior to the last decade it was common to hear statements like, "the stock market is a gamble". This was because in truth it is. Only recently have such statements as, "stocks are a form of savings" filled the airwaves. These conservative investors had taken to heart and understood the true nature of the stock market, and would normally have never considered investing in equities. Yet, the combination of their fear and the endless banter describing common stocks as a method of savings, combined with the widely fostered belief that stocks are assured to go higher in price over time, drove many of these poor souls into the stock market.
This is one of the reasons why stock prices have been so well supported during the past few years. Billions of dollars have been drawn into them by those whose desperation caused them to sell their conservative investments, and reinvest the proceeds into common stocks.
Today, these frightened and hard pressed individuals have their hopes and future pinned upon what I believe are a series of false beliefs. First, buying stocks are not a form of savings. Ask those who were late to the party and bought common stocks after the Bear Market began. Also, history shows that."stocks go higher over time" is only a half truth. This only occurs when the frame of reference is over a period of decades. For example, those who bought common stocks at the 1030 Dow Industrial Bull Market peak in1966, were forced to wait over 15 years to break even. The Dow Industrials did post a slightly higher interim top at about 1050 in 1973, but from there it collapsed to 577 less than two short years later. It was not until 1982, when it finally surpassed 1050. Or even worse, those who acquired common stocks prior to the great stock market crash of 1929, would not have recouped their losses until the late 1950's, when the Dow Industrials and S & P 500 again first surpassed their former peaks. How many of today's interest rate dependent investors can wait that long?
Gold has forever been the savior of the common man. Periods of excessive monetary creation, such as the path that the United States is currently following, have ravaged him by inflation unless he owned gold. In times when a country's monetary unit's existence came into question, such as when one nation conquered another, gold has saved the individual's wealth. So too is it today for those who believe that the only hope for their future exists by owning common stocks. They are misguided and should place some of their assets into gold. If I am correct, not only will the stock market trade far lower over time, but gold will soar to heights never before witnessed. This will preserve both the wealth and the future of those Americans who move their assets into the eternal metal, gold.
June 24, 2004
The above was excerpted from the July 2004 issue of Financial Insights © June 20, 2004.
I publish Financial Insights. It is a monthly newsletter in which I discuss gold, the financial markets, as well as various junior resource stocks that I believe offer great price appreciation potential.
Please visit my website www.financialinsights.org where you will be able to view previous issues of Financial Insights, as well as the companies that I am presently following. You will also be able to learn about me and about a special subscription offer.
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