The past 40 years have seen a slow, steady descent of interest rates falling, as globalization, demographics and fiscal policy have coalesced to contribute to this phenomenon. This has created an environment where longer term yielding instruments—such as treasury bonds—have consistently appreciated in price, because prices of yielding assets move inversely to their rate in a falling interest rate environment. If any of that does not register or make sense to you, read it again and again until it does. Or better yet, reach out and say hello and we will be happy to discuss it with you.
Now, the price of yielding assets going up may sound like a good thing, and maybe it is. We're not here to debate this point. It does however create problems along the way. Asset prices increasing tends to promote risk-taking and leverage. This in turn reinforces the cycle of price increases, which continues to beget more risk taking. As more and more leverage is introduced into the system, valuations have a tendency to get extreme. Debt is by its very nature a humbling tool.
There are only three ways a smart person can go broke: liquor, ladies and leverage. Now the truth is — the first two he just added because they started with L — it’s leverage.
- Warren Buffett quoting his business partner Charlie Munger
There is another reality about leverage and a debt-based system, it can really only end one way. With excessive indebtedness, reaching for yield and eventually interest rates that cannot rise, or else everyone who is heavily leveraged will be wiped out. Let us be very clear in saying this was always going to happen, and always will with our current system.
The minuscule or even negative interest rates you are seeing around the world are an orchestrated event. To keep the music going, central banks fully understand that rates must stay ultra low or even negative, to keep the music playing and the party rocking. It's the equivalent of continually spiking the punch stronger the later the night gets. We all know that does not end well.
When asset values go up, cap rates (or, the amount you can make owning assets) goes down. In this way, asset appreciation acts exactly like a bond. This creates a problem for anyone on a fixed income, or seeking yield from their investments. The best savings accounts pay 50 basis points or less, with bonds barely better than that.
So what is one to do? Clearly we can't just forgo the idea of cash flow in our investments, as the capital appreciation gambit of cryptos, stocks and other risky instruments will not last forever.
If any of this resonates with you, please reach out for a chat with YouAre | Abundant. We're here to help you create yield in this environment of endless uncertainty.