I was down at the barn working on a busted mower when a neighbor jogs by wearing white Nikes and a maroon tracksuit. I wave, he stops, says hello and asks:
“So when are you going to get those fences fixed?”
The guy has a point. The fences are shot. But this is an old barn, and the horses are long gone, so I don’t really give a shit about the damn fences. I tried for a second or two to think of a nasty response; the best I could come up with was:
It’s on the to-do list. It will happen when the S&P hits 1,800!
I don’t think he liked that answer, so he jogged off.
Actually, there was a fair bit of truth to my answer. My spending patterns have changed the past four years. I’m sure that there are many like me. In the aggregate, it is a phenomenon that is extending the economic slowdown.
I believe that one should own equities in an investment portfolio. I think there should be some discipline as to how large a percentage equities should be as share of the total. A long establish rule on this question is that one takes their age, and subtracts it from 100. The result is the percentage that should be dedicated to stocks. For a person who is 20 years old, 80% in stocks was the recommendation. For a guy like me, at age 62, the number falls to only 38%.
After fours years of ZIRP and QE you can take that old formula and kiss it good by. It doesn’t work in June of 2012; it’s not going to work anytime over the next five years. With interest rates now at levels guaranteeing a negative real rate of return well past 10 years, the allocation to equities has to go way, way up in order to have a chance of matching the real rates of return achievable five years ago.
The dilemma that I face is exactly what Bernanke wants me to confront. He wants me to be 100% in equities. He is convinced that higher stock prices are the only way to get the economy moving. At this point in history, I think that his actions are now slowing the economy.
Equity returns are, to say the least, unpredictable. Given that I have now near zero investment income that is “certain” (high grade bonds) I have changed my planning/spending habits. I used to be able to look at a spreadsheet in January, and know that in June my NYS Dormitory bonds were going to pay me $X. So I would note in the calendar to call the contractor (for whatever needed mending) at the end of April. No longer. All those nice bonds have been called or matured. Now I say to myself:
“If XYZ stock gets to 60, I’ll sell half, pay the taxes and put up the damn new fences in the pony paddock”.
I’m not asking for one lick of sentiment. My point is to describe something that I believe is a big drag on the economy. When I (and others) book a job three months in advance, the contractor can hire more workers knowing when checks will be coming in. My visibility creates the contractors visibility. The predictability of revenue creates the opportunity for economic expansion and job creation.
The Federal Reserve is operating monetary policy using a simple formula:
Lower interest rates across all maturities ALWAYS increases economic growth.
My personal example proves this formula to be flawed. I think the formula is more complicated:
Lowering interest rates across all maturities has both positive and negative consequences. As interest rates approach zero, (with the prospect that they will remain so for years to come) the negative consequences outweigh any benefits.
The idea that lower interest rates are hurting savers is an old one. The question is, "How significant are the negative consequences of low interest rates?" The multi-decade efforts in Japan to reflate an economy with low interest rates is a shining example of policy that has not worked.
I’ve not seen any discussion that attempts to quantify how large a drag on economic activity low rates are. I know that some of the folks at the Fed will read this; my request/challenge to them is that they respond with an answer.
If the Fed did a fair job of looking at this, and took into consideration all of the consequences of the prolonged zero rate policy, it would be forced to conclude that it is now causing more harm then good. I doubt that we will see an analysis from Bernanke's Fed that answers my question. The Fed has no incentive to document the downside of their policies. So much for that “Open Communication Policy” Bernanke keeps selling.
I know that some will be itching to point at dividend stocks as the answer to the need for predictable revenue. Those that tout this approach (especially those on TV) often point to two stocks that are perfect for coupon clippers, AT&T and Verizon.
I think that T and VZ are trading fodder for computers. They are fine stocks to “rent” from time to time in an effort to make a buck. But those that buy this stuff, and then go to sleep thinking their money is safe, are either ill informed or crazy. At 45++ Xs earnings an investor could lose five years of income in any given month.
I can’t wait to hear the howls from retail investors when this lesson is learned (it will be learned). When it does happen, those investors will blame Bernanke for forcing them into inappropriate investments. As well they should.
Social Security is a good example of where low interest rates are causing severe pain. The SS Trust Fund is sitting on a wad of cash. The interest on the portfolio was projected to extend the life of the Trust Fund for decades to come. Bernanke's zero interest rate policy will accelerate the death of the Trust Fund by ten years. What's that going to cost us? Trillions is the answer.
H/T: PE from Seattle