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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