Investing in a low interest environment

With high interest savings accounts paying below 2% and one year GIC rates at below 1.5%, one could be earning nominal or no after-tax return if your high interest savings account or GIC is held outside of a tax-deferred account. For those holding a large part of their retirement portfolios in cash or GIC, they may be opportunity costs to not shifting from cash or cash equivalent positions to higher yield fixed income instruments or equities.  Given these choices, what is one to do in an low interest investing environment?

Central banks across the world are maintaining low interest rates for a reason; to encourage investors to move out of cash and into higher yielding instruments particularly corporate bonds and equities as a means of recapitalizing private enterprise. The one flaw in the assumption is that people will act rationally to undertake the desired behavior modification.

Rationality is not a word I would use to describe the state of personal finance in 2009: “anything to survive” may be more of an adapt phrase. For this reason, some analysts believe that investment products that usually benefit in low interest environments are under-priced. What may some of these products be?

1. Corporate bond market. AAA rated corporate bonds yielding between 4-6%.  A yield higher than that typically implies higher risk of repayment.
2. Utility stocks. Typically quite sensitive to interest rates because of the highly leveraged nature of the business (not because of undue risk but because of the large amount of capital expenditures it must undertake to maintain the assets of the business). The lower the interest rate environment, the cheaper the cost of doing business.
3. Teleco stocks. Same reason as utilities.
4. Real Estate (under normal circumstances)- stocks and as investment properties. Another business which depends on leverage and thus fares better in low interest rate environments. Of course, if this was a “normal” recession, this analysis would hold true. But where a recession is caused, in part, by a large correction in real estate valuations, you have to pick and chose your spots.
5. Bank stocks (under normal circumstances)- banks usually lead recoveries because the typical economic stimulus in downturns (which we are seeing now) is to lower the cost of lending/return on cash in order to encourage lending-the traditional bread and butter of financial institutions- and encourage investors to stop hoarding cash. But no one is quite sure if banks are out of the woods yet;  some believe the other shoe has yet to drop on banks looking at  rising credit card delinquency rates and increased defaults on corporate loans.

One huge caveat though. Many observers expect that the government is solving one problem by creating another. Throw enough money at any issue and you will solve it. Thus, the fact that financial institutions are starting to get back on their feet is not startling news a trillion dollars later. The issue is that rapidly increasing money supply typically leads to inflation, meaning there may be more of a probability of a 1970’s hyper-inflation environment than a 1930’s style depression.

The typical monetary tool to fight inflation is to raise interest rates or choke off the money supply, both moves will have the same negative impact on the above stocks. Therefore, if inflation arrives sooner rather than later, the return on these products may be decreased.

Thus, caution should be exercised in deciding on any investment strategy based on short-term trends. Certainly, there are  better opportunities out there than high-interest savings account or a GIC but it would be imprudent for most retail investors to swing widely from one extreme to another in such uncertain times. A well-balance portfolio should be maintained at all times to weather all economic circumstances.

Finally, I would suggest the best investment of all- yourself. With just about every good or service to be had on the cheap, it may be a good opportunity to devote some resources to improving yourself whether through formal re-education, seminars or resources. Products come and go but there is only one of you in life.