What do low interest rates mean for the future?

By DAVID MOON, Moon Capital Management, LLC
June 28, 2009


In his book “Black Swan,” Nassim Taleb explores the tendency that many of us have to dismiss as impossible a certain event simply because it has never previously occurred or we’re not aware of it occurring. Most of us have never seen a black swan, so it’s not too difficult for us to conclude that they probably don’t exist.

Except that they do.

The easiest things in life to prepare for are the expected. I am not shocked when my alarm clock goes off because it happens every morning. If, instead, I am awakened in the middle of the night by a would-be intruder, I might be unprepared.

My dogs are unencumbered by this Black Swan phenomenon, so I don’t suggest sneaking up to my house unannounced.

For many investors, a Black Swan financial event would be anything other than a prolonged decline in interest rates. After all, interest rates have been in an almost constant state of decline since 1982. Corporate earnings have vacillated. We’ve had recessions and wars. Oil prices have gone up and down.

But interest rates have bounced steadily along a downward slope.

It’s easy to overlook, but declining interest rates might be the single most influential investment factor of the last quarter century.

Lower rates are responsible for increases in the pre-tax profit margins of most companies that borrow money. From 1982 to 2008, the average yield on AAA-rated corporate bonds declined from 15.2 to 5.6 percent.

Lower rates have often been a part of Federal Reserve policy aimed at supporting parts of the financial markets – often the stock market.

Generally, lower rates increase the value of any asset whose value depends on a stream of fixed income. This includes most bonds, stocks and income producing real estate.

What happens if, in the next five or ten or 25 years, interest rates don’t continue the same decline they’ve enjoyed over the last quarter century? Are you or your dogs ready to deal with that wake-up call?

Low rates have supported an investment advisory industry whose Pavlovian response to any stock price decline is “don’t do anything. It will come back.”

It’s easy to hold that opinion when, in your adult life, that’s always quickly happened. But what if? What if one of the primary foundations of swift, broad stock market recoveries can’t be replicated in the near future?

Will the recovery be as broad? That is, will the prices of all or most stocks recover in relative proportion to their declines? Or will some do better than others?

Will the recovery be swift? Easy and inexpensive money has lent its support to previous rapid recoveries following broad market sell-offs in 1987 and 1990. Will the decline of 2007-2008 be the same?

It’s not only dangerous to try to predict short-term movements in the stock market; it’s impossible to do so with any regular accuracy. It’s silly to try.

But it’s just as silly to ignore the fundamentals.


David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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