The U.S. Federal Reserve has slashed already-low interest rates to zero. They are taking other measures to preserve credit and pump money back into the system. But, the steady spread of the coronavirus and predictions of 20% unemployment and worse are unsettling markets as investors wonder how far stocks will fall. As the economy contracts we will see the possibility of interest rates going below zero. How will negative interest rates affect your investing?
How Will Negative Interest Rates Affect Your Investing?
Forbes wrote a useful article a year ago about the damage negative interest rates would do to money market investments. The bottom line of their long discussion is that safe investments will no longer be safe. In our article about how to invest without losing any money, we looked at bonds, CDs, and money in the bank. The usual rationale is that you accept a moderate to low interest rate and forego the opportunity to make a lot of money.
But, your capital is always safe.
But, if interest rates go negative, you will be paying the bank for the privilege of parking your money with them. Either you will have to keep paying monthly for your deposits or they will simply deduct from the balance until your investment is gone!
Stock Investments When Rates Are Negative
Investopedia has an informative piece about the stock market and interest rates.
When the Fed changes interest rates, it affects markets in both direct and indirect ways as borrowing becomes more or less costly for individuals and businesses.
The stock market’s reaction to interest rate changes is generally immediate, however the real economy takes about a year to see any widespread effect.
Higher rates tend to negatively affect earnings and stock prices, with the exception of the financial sector – and vice-versa.
While the effects of interest rates have a delayed effect on things like the housing market, the stock market reacts immediately because the stock market predicts the future and adjusts.
In general, lower interest rates are good for business because companies can borrow money at lower rates and pay back more comfortably. The prospect of negative rates means that a company could get a low and also get routine “reverse” interest rate payments.
But, since banks will have to pay you money in order to loan you money, they may be resistant to lending, especially to the sort of “zombie companies” we mentioned in our article about whether debt will destroy your investment portfolio.
What Should You Do?
The folks at Yahoo Finance interviewed Warren Buffett in regard to negative interest rates.
First, Buffett conceded that in general the bond market with its super low rates, and wildly swinging yield curve, “is really crazy.” But then he made it clear that neither he nor his partner Charlie Munger have any expertise or any interest in predicting where interest rates are headed.
“Charlie and I focus on what’s knowable and important,” he said. “Now, interest rates are important, but we don’t think they’re knowable.”
This gets us to our usual starting point, intrinsic stock value. This is all happening because the economy and corporate earnings are being hit hard by the coronavirus and the prospect of a depression and financial collapse. For an investing perspective, what companies will weather the storm? It will be those with a combination of continued earnings and low debt. The point is that companies that already owe money will still need to pay off their debts with lower income. The beer companies, folks like Coca Cola, and Clorox will likely do just fine. Tesla might be in trouble with its huge debt but Amazon’s large debt burden may shrink as the company gets even busier making home deliveries during the ongoing crisis.