What Would Negative Interest Rate Mean For Investors : A Memo From Howard Marks
Howard Marks, founder and co-chairman of $122
asset manager Oaktree Capital Management and author of many best selling
books ( including the recent one “ Mastering
The Market Cycle”) had just published his latest memo.
“And that brings us to the subject of negative interest rates. I find them no less mysterious. The fact
that we know what they are – as we do with inflation and deflation – doesn’t
alter the fact that we don’t know for sure why negative rates are prevalent
today, how long they’ll continue in force, what might cause them to turn
positive, what their consequences are, or whether they’ll reach the U.S.”
In this latest memo titled “Mysterious”, he starts with a discussion of many
possible causes of inflation and the implication of negative rate to our investment
and financial institutions, he finds negative interest rates just as baffling and
“mysterious”.
Marks touched on several reasons for them, including
economic stimulation, as well as the impact they have on the market and
economy.
He also not sure if the U.S may
end up like Japan and Europe to have a negative rate anytime soon by looking at
how the FED reacted to global interest rate and the US dollar’s movement.
His main concern is….
"There’s so much money in
the system that the excess of supply over demand drives down the price of money
– borrowing rates – into negative territory. 'In today’s global economy,
private investment demand is manifestly unable to absorb private savings...
.'".
At a minimum, negative
rates mean there’s increased uncertainty, and thus we have to proceed with more
trepidation. Whatever we knew in the past
about how things worked, I think we know less when rates are negative.
“Negative rates make life more
difficult in a TINA (“there is no alternative”) world. Many investors
don’t want to knowingly sign on for negative rates. That
makes risky investments preferable, even if they promise historically low
prospective returns. In this way, risk aversion is discouraged. “I
have no choice but to go into risky assets because I can’t accept a negative
return on safe ones.”
“Negative interest rates are nothing short of a mystery,
they’re likely to throw off whatever we knew about the financial world and how
things worked in the past when we have to put a “negative figure “ in
the discount rate when he mentioned
“ Negative
rates can warp the calculation of discounted present values. In particular, when
the discount rate is negative, the present value of future pension obligations
can exceed their future value. The combination of high discounted
obligations and low yields on investments can be disastrous for the
funded status of pension funds.”
All the conventional way of using the “discount rate “ to get an asset valuation will go haywire and distorted when we have to put a negative figure
into the DCF ( Discounted Cash Flow ) model.
Negative
Discount Rates: Discounting dilemmas <source:ipe.com>
The final thoughts from Mark’s Memo…..
“In a world like the one described above,
perhaps the most reliable solution lies in buying things with durable cash
flows. Bonds, loans, stocks, properties and companies
with the likelihood of producing steady (or hopefully growing) earnings or
distributions that reflect a substantial yield on cost all seem like reasonable
responses in times of negative yields. In my view, durability and dependability are
highly desirable (rather than hail-Mary attempts at a moon-shot). ”
“While
all this might be self-evident, the challenge lies in accurately predicting the
durability and growth of cash flows and making sure the price you pay allows
for a good return. In today’s market environment, assets with
predictability are often priced extraordinarily rich, and investors are unusually
willing to extrapolate growth far into the future. At the same time, with
the economy and markets operating under rules that are different from those of
the past in many ways – some of which are reflected above – accurate
predictions are apt to prove harder to make than usual. These are some of the reasons why, while
simple in concept, investing is far from easy . . . especially today.”
The key is investing in an asset that
producing “ sustainable & predictable “ cash flow….. of course, REITs are
not as qualify as good quality bonds, but an asset class which is in between bond
and equity, I think it deserves a substantial position in our portfolio.
As mentioned in my previous blog post
( here
), I am going to further increase the % of REITs in my portfolio, which is about 47.5% to maybe over 50%. I hope this is the right choice in the current
low or negative interest environment.
How about you, what is the % of REITs
in your portfolio?
Cheers !
< % of REIT increase by +2.4% as of Nov 2019 vs Dec 2018 >
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