Can Easy Money and Low Interest Rates Last Forever?

North American markets today, Friday, viewed several hours before opening at 9:30 a.m. EST, appear set to start positive with all major indicators in the green. The DOW, NASDAQ and Canada’s TSX 60 are especially strong at time of writing. All are driven by Senate passage of a plan to push stimulus legislation through regardless of Republican support, a belief that today’s jobs report will show improved employment growth, positive earnings reports and relative political peace. Earnings reports expected today include Regeneron Pharmaceuticals Inc., likely to record increased revenues in its fourth quarter from sales of its COVID 19 drugs and Estee Lauder Cos. Inc, likely to record a drop in cosmetics sales for its second quarter during the crisis.

European markets are already open at time of writing and indicators there including the FTSE 100, DAX and CAC 40 all strongly in the green. The safe havens of gold and silver are up, as are the Canadian dollar, British pound and Euro.

To suggest that this has been a wild week on the markets understates what has happened. However recent events highlight questions worth considering.

Yesterday proves once again the relationship between the markets of Europe and North America and at time of writing it remains to be seen whether they will continue following yesterday’s pattern.

Since the Bank of England looks unlikely to cut rates anytime soon, the FTSE held back but the British market drew some optimism from North America says one analyst. “(Meanwhile,) wider Western market optimism comes as a stimulus boost looks likely to coincide with a recovery phase for the US economy,” suggests Joshua Mahony, Senior Market Analyst at IG Group, a London stock firm. 
“The FTSE 100 is lagging its American and European counterparts,” Mahony says, pointing to concerns flowing from Asian markets that this week’s risk-on sentiment would come to an end.

Still, notwithstanding incoming U, S. Treasury Secretary Janet Yellen’s failure to take major steps to combat recent volatility, the optimism generated in North America continues, he believes. 

“Meanwhile, with the US jobless claims figure highlighting an improved employment picture, the impending Biden stimulus package provides the feeling that we will see a double boost in the coming months.” Mahony believes that short-term weakness can be tolerated as long as the vaccination program unfolds and that quantitative easing, reduced rates or negative rates are unlikely this year. Despite the Bank of England’s warning of possible negative rates “…true market expectations have been highlighted by the sharp rise in banking stocks.”

A less appetizing but no less important question involves the so-called easy money which is one of the major factors currently driving the market. The returns are great, but I would have to submit that they cannot continue indefinitely. Someone remarked that if the valuation for TESLA continues increasing at the current rate until the end of the year, it would be near a trillion dollars.

Even the most optimistic of market optimists might agree that these gains cannot continue indefinitely. Although it appears that the volatility of recent weeks will continue, the easy money and low interest rates cannot last forever. At some point, the government will want to turn off the tap.

And perhaps the question that has been at front of mind for many this week was the frenzied trading generated by chat rooms inhabited by young traders who styled themselves as gung-ho mavericks going up against the Wall Street denizens that they believe take advantage of investors. The details are well-known –- first they drove up the share price of GameStop Corp., a bricks-and-mortar operation., then AMC Entertainment which has hovered near bankruptcy for several months, and then silver.

As the smoke clears, the episode suggests several brass-tacks realities according to Jay Nash, Senior Vice President at National Bank Financial in London. Nash says that the outcome was not surprising. “Despite all the noise about Reddit’s efforts being a “win for the little guy”, or United States politicians suggesting that this (episode) is proof that rules have to change, I would suggest that the capital markets are behaving exactly the way they should,” he says.

Neither GameStop nor AMC have the fundamentals to justify the valuations that they reached in the frenzy. In fact, AMC Entertainment has hovered near bankruptcy and faces an uncertain future. “There is a fundamental value of each company and to suggest that it’s worth more than ‘the sum of its parts’ just because you want it to be is never going to be a winning strategy,” Nash says.

Sadly, we cannot believe that it will not happen again. In the end the GameStop effort was nothing more than a ‘pump and dump’ strategy where those who don’t get out lose a LOT of money. “It WILL happen again because a few got very rich in the effort,” he says. Preventative measures are also suspect. “Only time will tell if the legal system is able to deal with this properly. Too many investors with limited investment knowledge have been hurt,” he says, adding that preventing this week’s level of frenzy is near impossible. “If new regulations are put it will have little impact. Purely symbolic. If the regulations go too far, they inhibit capitalism itself.”

The anomaly s that Robinhood was nearly taken down by regulators as their capital requirements for such heavy trading were more than the company had available, leading to the need for billions to keep the company afloat.

As the week winds down, investors can be forgiven for quietly asking themselves “OK, so now what do it I do?”

The solution is to recognize that nothing can go on forever, according to Gavin Graham, United Kingdon-based financial analyst and media commentator. “Knowing a market or individual stock is over-valued does not tell you when the market will begin to recognize that,” he says. Investors have to tread carefully when a frenzy erupts even when potential returns look overwhelmingly appealing.

“Beware of speculative excess abounding, whether from Reddit-fuelled buying sprees in uninspiring companies such as AMC and GameStop or the Price/Earnings Ratio of the S&P500 at an all-time high for the last century and the percentage of market capitalization to GDP at the same level as during the tech bubble of 1999-2000, he warns.

A strong solution would be taking some of the profits made recently and invest them in sectors or companies that may have lower valuations but may have better dividends, providing both income and possibly some stability in these volatile times.

High-flyers and rocketing returns may be appealing but they can be dangerous.

As I have said in earlier columns, the first goal of investing is not to make money. (I get many quizzical looks when I say that.) The first goal of investing is not to lose money.

Nor is the second goal of investing to make money. The second goal is to be able to sleep at night. The third goal of investing is to make money.

Disclosure: I do not own any shares in any company  mentioned in this column.

Related: The Divide Between Governments and Markets