The “crisis” that never comes
The recent deficit talk has people rightly concerned about whether or not Congress and the President have the cojones to bring our fiscal house in order. There are basically four ways to cut the deficit: grow the economy, cut spending, raise taxes, or print money.
Option one is the fun way to get out of it. If we sell more goods and services, government collects more taxes while citizens make more money, and everybody’s happy. However, the economy right now is growing slowly.
Options two and three are where all the debate is happening. However, political risk is frightening most politicians from addressing the beasts of healthcare and Social Security that need to be tamed for any real progress to be done.
Which leaves option four as the default way to pay. If Congress does nothing to fix the deficit, the government can “print money” to devalue those debts, which drives interest rates up and the dollar down. Bad for savers. Good for debtors.
While you might understand how all that could eventually affect inflation and the prices you pay for goods, you might be left scratching your head about just how much of a knock on your savings that last solution could translate to.
Here’s an attempt to explain it without getting too wonky or insulting your intelligence. But first, let’s set one thing straight.
Inflation is not here yet.
I’m kind of tired of the “is there or isn’t there” inflation debate going on right now. The government’s official inflation measure showed that prices rose by about 1.6% over the last 12 months. Food and energy prices accounted for more than two-thirds of the increase.
Inflation of less than 2% is extremely low, especially when you’re including food and energy prices, which swing up and down sharply based on crop yields, hurricanes, etc. Critics like to counter with nice-sounding anecdotes about how their personal grocery bills are rising. But even if we were to accept anecdotal evidence as valid, there’s reason to think those anecdotes are wrong.
Here’s the average grocery store purchase at a Hy-Vee in Des Moines, according to Mint:
This chart is based on data aggregated anonymously from over 4 million Mint.com users.
Go to Mint’s data feed yourself and play around. Grocery bills aren’t going up. Unless people are eating less, or deciding to make multiple trips to the store in order to keep their average order down (diabolical!), it’s simply not true that grocery prices are already on the upswing.
But it could happen soon. As the WSJ points out today, the prices for some things are rising faster, and inflation is already much worse in places like China, where there’s not a bad economy to weigh against price increases.
I’ve written before about good and bad inflation fighters. But today, I want to write specifically about how rising interest rates could affect stock prices.
Starting with a risk-free rate of return
If you wanted there to be no chance for your investment to lose money, where would you put it? FDIC-insured bank accounts come to mind, but you’d do slightly better by investing in 10-year Treasury bonds, which yield about 3.6% a year right now. Don’t get me wrong. If interest rates rose while you had your bond, the price would go down in the interim. But as long as you held onto them for the entire 10 years, you couldn’t lose a dime unless the federal government were to default.
That’s about as close to risk-free as investors can get right now. And that means that anything they invest in that carries more risk needs to pay out more than 3.6% a year to make sense as an investment.
The bonds of Warren Buffett’s Berkshire Hathaway, for example, would seem to be extremely safe. It’s a big, established company that’s generating a lot of cash. But the yield of a Berkshire bond I’m looking at that matures in 2021 is 4.2%. That means that as safe as Berkshire is, investors want another 0.6 percentage points to take on the ever-so-slight risk that Berkshire goes belly-up before the bond matures.
As you can imagine, once you start getting down to auto companies, those bond yields start to get really high.
What it means for stocks
Stocks also have a yield, though personal finance magazines like to make it appear more complicated than it actually is. The “price-to-earnings” ratio that you read about all the time is really just an earnings yield in reverse. A stock with a P/E of 15, for example, has an earnings yield of 6.7% (1 divided by 15).
Since stocks are more risky than bonds, investors want to pay a price on a company’s stock that reflects the additional risk they have to take on. The price-to-earnings ratio of Berkshire Hathaway, for example is 17.6, which translates into an earnings yield of about 5.7%. (Admittedly, a P/E isn’t the best way to evaluate a holding company like Berkshire.)
So, what happens when the interest rates on Treasury bonds rise? Let’s say the interest rate on a 10-year Treasury bond went to 10%, as it was in the early 1980s.
An investor could earn 10%, while taking no risk, by buying Treasury bonds. So if he considered buying a stock, which carries a lot more risk, instead, he’d want to get a yield that’s better than that.
The earnings yield of the S&P 500 right now is about 4.3% (which is a P/E of about 23). So to get even close to the 10% yield of a Treasury bond, you’d need stock prices to fall by more than half.
In reality, the drop would be much less sharp—earnings would rise, too. But P/E compression, as the phenomenon I just described is called, is a very real fear that investors haven’t had to face for 20 years, since during that time bond rates kept dropping.
Long story short…
If investors fear inflation, and start to demand higher yields from Treasury bonds, that will mean that stock prices will have to make a corresponding drop, all else being equal. Stocks have benefited from a 20-year or so long-term drop in Treasury yields. But that party’s over.
Is there anything you can do to protect yourself from it? Not really. You could choose stocks that already have low P/Es, with the idea that those prices won’t compress as much when interest rates rise. However, buying individual stocks carries so many other risks, that it’s probably not worth your time, effort, or emotional fortitude to go through all that.
It’s just one of those things that you should save more to prepare for and to understand once it does start to happen. This deficit monster is probably going to extend its tentacles into more aspects of our finances than we can even conceive of.
I, for one, am hoarding piles and piles of gold bullion in an undisclosed location. So when Zimbabwe-like inflation causes food riots, I can…eat it…or something.
{ 184 comments… read them below or add one }
← Previous Comments
Автор старается представить материал нейтрально, оставляя пространство для собственного рассмотрения и анализа.
Статья представляет несколько точек зрения на данную тему и анализирует их достоинства и недостатки. Это помогает читателю рассмотреть проблему с разных сторон и принять информированное решение.
Asking questions are truly pleasant thing if you are not understanding something completely, except this article provides pleasant understanding even.
Статья содержит анализ преимуществ и недостатков разных решений проблемы, помогая читателю принять информированное решение.
Эта статья действительно заслуживает высоких похвал! Она содержит информацию, которую я долго искал, и дает полное представление о рассматриваемой теме. Благодарю автора за его тщательную работу и отличное качество материала!
http://iot.ttu.edu.tw/members/hopedill19/activity/1963394/
Автор предоставляет достаточно контекста и фактов, чтобы читатель мог сформировать собственное мнение.
Статья содержит информацию, подкрепленную фактами и исследованиями.
Simply wish to say your article is as amazing. The clearness to your put up is just spectacular and that i could suppose you are an expert in this subject. Fine together with your permission allow me to grasp your feed to keep up to date with imminent post. Thank you a million and please keep up the enjoyable work.
Мне понравилась объективность автора и его способность представить информацию без предвзятости.
https://bybak.com/home.php?mod=space&uid=3802870
Magnificent site. A lot of helpful info here. I’m sending it to several friends ans also sharing in delicious. And obviously, thanks for your sweat!
Я оцениваю четкую структуру статьи, которая помогает организовать мысли и понять ее содержание.
Очень интересная исследовательская работа! Статья содержит актуальные факты, аргументированные доказательствами. Это отличный источник информации для всех, кто хочет поглубже изучить данную тему.
I could not refrain from commenting. Perfectly written!
Автор статьи постарался подать информацию без предвзятости, приведя разные аргументы и точки зрения.
Я оцениваю использование автором разнообразных источников, что позволяет получить всестороннюю информацию.
Статья содержит дополнительные ресурсы для тех, кто хочет глубже изучить тему.
Excellent way of telling, and fastidious piece of writing to obtain facts about my presentation subject, which i am going to deliver in college.
Я хотел бы отметить глубину исследования, представленную в этой статье. Автор не только предоставил факты, но и провел анализ их влияния и последствий. Это действительно ценный и информативный материал!
Автор предлагает практические советы, которые читатели могут использовать в своей повседневной жизни.
Я очень доволен, что прочитал эту статью. Она не только предоставила мне интересные факты, но и вызвала новые мысли и идеи. Очень вдохновляющая работа, которая оставляет след в моей памяти!
В современном мире, где онлайн-присутствие становится все более важным для бизнеса, повышение видимости и ранжирования сайта в поисковых системах является одной из самых важных задач для веб-мастеров и маркетологов. Одним из основных факторов, влияющих на рост авторитетности сайта, является его DR (Domain Rating), который определяется в основном путем анализа ссылочной массы сайта.
Статья предлагает широкий обзор темы, представляя разные точки зрения и подробности.
It’s going to be end of mine day, but before end I am reading this great article to improve my experience.
Автор статьи умело анализирует сложные концепции и представляет их в понятной форме.
Автор статьи представляет информацию, основанную на разных источниках и экспертных мнениях.
Hey There. I found your blog using msn. This is a very well written article. I will make sure to bookmark it and come back to read more of your useful information. Thanks for the post. I’ll certainly return.
Я оцениваю умение автора объединить разные точки зрения и синтезировать их в понятную картину.
I simply couldn’t go away your website prior to suggesting that I really enjoyed the usual info a person supply in your guests? Is gonna be again incessantly to inspect new posts
Статья содержит обоснованные аргументы, которые вызывают дальнейшую рефлексию у читателя.
Я рад, что наткнулся на эту статью. Она содержит уникальные идеи и интересные точки зрения, которые позволяют глубже понять рассматриваемую тему. Очень познавательно и вдохновляюще!
Эта статья является примером качественного исследования и профессионализма. Автор предоставил нам широкий обзор темы и представил информацию с точки зрения эксперта. Очень важный вклад в популяризацию знаний!
Статья содержит достоверные факты и сведения, представленные в нейтральной манере.
Я чувствую, что эта статья является настоящим источником вдохновения. Она предлагает новые идеи и вызывает желание узнать больше. Большое спасибо автору за его творческий и информативный подход!
Heya i’m for the first time here. I found this board and I find It really useful & it helped me out a lot. I hope to give something back and aid others like you aided me.
Статья помогла мне лучше понять сложные взаимосвязи в данной теме.
Hi to every , since I am genuinely eager of reading this webpage’s post to be updated regularly. It consists of good stuff.
Статья представляет интересный взгляд на данную тему и содержит ряд полезной информации. Понравилась аккуратная структура и логическое построение аргументов.
Автор старается сохранить нейтральность, предоставляя обстоятельную основу для дальнейшего рассмотрения темы.
Автор старается сохранить нейтральность, чтобы читатели могли сформировать свое собственное понимание представленной информации.
Автор предлагает анализ преимуществ и недостатков разных подходов к решению проблемы.
I do trust all the ideas you have offered in your post. They are very convincing and will definitely work. Still, the posts are very quick for beginners. May just you please extend them a bit from next time? Thank you for the post.
Я ценю фактический и информативный характер этой статьи. Она предлагает читателю возможность рассмотреть различные аспекты рассматриваемой проблемы без внушения какого-либо определенного мнения.
Статья помогла мне получить глубокое понимание проблемы, о которой я раньше не задумывался.
The passion isn’t just inspiring—it’s downright seductive. Who knew a subject could be this enticing?
Engaging with The Writing is like savoring a gourmet meal; every bite (or word) is to be enjoyed.
Shedding light on this subject like you’re the only one with a flashlight. Refreshing to see someone who thinks they have all the answers.
This post has been incredibly helpful to me. The guidance is something I’m truly grateful for.
The attention to detail is remarkable. I appreciate the thoroughness of The post.
← Previous Comments
{ 1 trackback }