Why Are Interest Rates So Low?

Quite frankly, I don't really know and I can't make heads or tails of it. The current environment is a classic case of my habit of missing regime/paradigm shifts. The scales usually drop way after the trend or the event has manifested itself.

There are numerous reasons posited:

• Savings glut (this one is a mystery to me when you look at savings rates relative to history and trends...the argument is the savings glut comes from China/Russia/Brazil).
• Supply deficit (can't quite work this argument out; I think it relates to QE and lack of collateral).
• QE (combination of reduced supply and scramble for collateral).
• Financial repression (combination of debt overhang and distorted price signals from QE).
• Low inflation (yes inflation is low and has been trending down...let's call it declining inflation, but it is still positive and real rates are low). 
• Fears of deflation (I don't see deflation...commodities have taken it on the chin in the last year, but asset prices have gone through the roof and commodity prices are cyclical).
• Fears of market collapse/capital protection (maybe...but those Wally's have all missed the boat).
• Currency wars (fight to the bottom). 

I just can't understand why any investor would settle for a negative interest rate. This makes no sense to me at all. US rates look as attractive as ever relative to European rates. European rates are crazy. What are they telling us? Imminent collapse in the Euro? Maybe!

It should be noted, that you can't talk about why interest rates are so low in the US without taking account as to why they are so low (or even much lower) elsewhere.

Distorted Price Signals

ZIRP distorts price signals throughout an economy.

Starting with asset prices and asset pricing, ZIRP creates not just a moral hazard by allowing firms to borrow at low rates to buyback stock (thereby boosting EPS and distorting that important price signal) but also factors prominently into asset valuation models artificially lowering the discount rate (which has a multiplicative and not a linear effect in valuation) to distort asset prices with follow-on effects for M&A and resource allocation decisions throughout the economy.

ZIRP just throws the cat among the pigeons. And so long as everyone is dancing to the music, it creates a game of chicken whereby everyone knows it will end badly one day, but everyone is also planning on being the first out the door when the music stops.

Current Economic/Market Flashpoints

Unprecedented debt accumulation in China, US, Japan, Australia, UK and other places.

The large decline in oil decimates one of the primary drivers of growth in the US.

The large decline in commodity prices due to the slowdown in China crushes Canada, Brazil and Australia.

Large residential real estate bubbles in Canada, UK, Australia, NZ and China undermine banks in those countries.

QE in Japan and by the ECB sets up a race to the bottom in the currency wars. US can't exit QE because it would blow apart global currency markets.

NIRP set up incentive structures leading to asset mispricings and misallocation of resources.

Financial repression and the failure to reform or clear markets is manifesting in deflation. 

Geopolitical instability with potential spillover effects: Ukraine, Syria, Grexit, oil squeeze on Iran & Russia.

Plenty of Room for the Major Indexes to Go Higher

In homage to Herman's Hermits, "2nd verse, same as the first..." (this was the same case I made in March 2014)

With large cap tech trading at middling multiples (15x) there is still room for the major large cap indices to go higher.

If large cap tech were to play catch-up (moving from 15x to 18x) it would also likely underpin the rest of the market (maybe even add a little to their valuations) and could see the general market indexes rise another 15%-30%.

Last year at this time we saw the high beta momentum plays get hung drawn and quartered even as large cap tech underpinned the "broader" strength in the market. I say "broader" because breadth actually deteriorated significantly (small-mid caps were hammered) but this was not so evident from the large cap major indices.

The New Dividend Investing Approach Is The Same As The Old Dividend Investing Approach

QE and financial repression through ZIRP have pushed up prices and forced savers into riskier investments.

One area where investors are doing a deal with the devil is dividend paying stocks. Investors are being pushed up the risk curve (by pushing up prices), hoping that an investment in a dividend paying stock is better than a non-dividend paying stock and that such an approach serves as a proxy for bond yield.  They are wrong on both accounts. Theory posits that there is no difference between a dividend paying stock and a non-dividend paying stock (Modigliani equivalence theorem). Evidence shows that when the market swoons, dividend paying stocks swoon just as much as non-dividend paying stocks. Equity risk is still equity risk. If it is true that ZIRP has artificially pushed up dividend stocks relative to non-dividend stocks, then there will be an additional cost to pay when valuations across the equity market equalize.

Hoping that dividend paying stocks provide a bond-like cushion with equity like appreciation is wishful thinking. There is no free lunch in the markets.

Additional Notes:

This is true of investors seeking dividend cover in tech stocks. I doubt they are fully factoring business risk.

It is especially important for investors to not be pennywise and pound foolish. Seeking a 3% yield vs a 2% yield for the market infers taking on additional risk. And it is especially important for investors to beware the addition of a 3% yield pales in significance to a 25% fall in price.

Finally, once dividend cuts come down the pike they have a double whammy effect wrt to falling dividend and falling price. What worked on the way up - increasing dividend, increasing price - works in reverse on the way down (as Cramer would say, "that is a house of pain")

The State of Financial Consultant Direct Calls

Just received a call from a TD Ameritrade Consultant who had taken over my account (I didn't know I was part of someones book) from a guy who has moved on from TD...It was not particularly compelling.

She had recently come over from Schwab having been at Schwab for six years prior. Doesn't inspire confidence when you see the revolving door of financial consultants.

Several things she said left me incredulous:

• In the first instance she mentioned they were doing a sales promotion - ding! ding! ding! I don't like being sold to - that would reward me with $100 for every $25,000 I moved over (0.40% - you've got to be kidding me). 
• In the second instance she tried selling me on some management program (forget the name I have seen it advertised before) explaining how it uses independent research house Morningstar to construct portfolios from the best 37,000 mutual funds (emphasizing twice that 37,000 number to highlight how difficult it is to navigate the financial marketplace). I asked whether that included Schwab and Fidelity funds which she had dished previously as implying their programs were biased by including them, and she was not sure. And when I asked if any Fidelity and Schwab funds might rate well, she unbelievably said she didn't think so (remember, this is someone who has been selling Schwab funds for six years).
• She indicated the fees for the managed program ranged from 0.3%-1.25% with an average of 1%. Ouch. 1% for a little bit of automatic tax harvesting. That can't end well. 
• She spoke about Tony Robbins new book that raved about TD Ameritrade as though he were an authority upon the subject.

If that is the state of Fidelity, Schwab, TD Ameritrade direct sales then they really need to sharpen their pencils. They are in pole position with their existing clients and it really shouldn't take much to upsell additional services.

The Only Spending Rule You Will Ever Need

From Financial Analysts Journal article by M. Barton Waring and Laurence Siegel.

It may be a slight overstatement but they make the case that the decision rule you want to work with in the decumulation phase if you don't want to run out of the money is as follows:

"Each year, one should spend (at most) the amount that a freshly purchased annuity - with a purchase price equal to the then-current portfolio value and priced at current interest rates and number of years of required cash flows remaining - would pay out in that year." [they call this the annually recalculated virtual annuity or ARVA]

Investors who behave in this way will experience consumption that fluctuates with asset values, but they can never run out of money.