Negative Interest Rates – The Unintended Consequences
Skerritts View - May 2016
The whole idea of negative interest rates, as introduced by the Bank of Japan recently and mooted (if not actually quite reached) by the ECB, is one that our clients are struggling to understand. With many of us having lived through eras of double-digit mortgage rates it is a concept that belonged strictly in La-La Land. Indeed, even such influential figures as Mark Carney and Janet Yellen (Bank of England and Federal Reserve respectively) seem to have difficulty in comprehending that the world changed so dramatically after the Financial Crisis of 2008 by their repeated use of the word “normalisation” when referring to the interest rate environment. Eight years on from the Crisis and they’re still expecting their normal to return. It won’t – or at least not for a very long time.
From what we’ve recently witnessed though, negative rates will not become the new normal either. Bear in mind that negative rates are supposed to indicate that there is no limit to which Central Bankers will not go to in the event of necessity. Negative rates are supposed to oil the economy. After all, surely the cost of borrowing can’t get any lower than minus?
In reality, negative rates had the opposite effect as banks had to pass their margins on to someone, and that someone was borrowers. So negative rates had the effect of making borrowing more expensive, not less. And the unintended consequence on the back of all of this? The fact that the Bank of Japan was trying to signal that there wasn’t any limit to how low rates could be cut, when in fact – by actually turning negative and finding that this was not going to work – they have signalled that rates are exactly at their limits and can not go any lower, indicating that there is no ammunition left to fire.
This has been our biggest fear this year. In January we said that this year may be the year that the world found out that the Central Banks had nothing left. The recent rally in equities has left our fear looking like an unfounded one, but then we have not really had a crisis this year to deal with.
That favourite old strap line gets trotted out every year around, er, May, so it’s as good a time as any to consider its relevance this time around. As we say, we have not really had a crisis yet, so what could possibly upset the carte du pommes this Summer? Brexit, of course, is one thing. We have stated previously that we expect it to be a closer vote on the day than the bookies are currently pricing in, and recent polls suggest as much. Our stance is still to expect Sterling to weaken as we approach June 23rd, even if an outright Out vote would ultimately be a surprise.
What others have failed to spot on the horizon is a repayment of €4.3 billion by Greece on July 20th. Now, it’s pure guesswork on our part, but we would have a stab at saying that the full amount won’t be there on that date. Angela Merkel, however, promised her voters in 2010 that every single Euro that was lent to Greece would be repaid. The IMF would like her to be lenient, but a stand-off and an all familiar bout of doubt could well ensue. The markets are unlikely to see a resumption of the Greek situation within Europe as a good thing, but what if this situation arises less than a month after the UK has voted to leave the EU? Speculation, indeed, but as investors we have to try to foresee problems ahead. Consequently, we will not be chasing the rally that has occurred since February 11th and will wait patiently for a more attractive point in which to join any upward market momentum.
One of the strangest theories that we have seen recently was put forward by BCA Research whereby they introduced us to a little known phenomena called “the lipstick effect”.
We mentioned last month that only a relatively small percentage of the population is actually benefiting to any great extent from the apparently healthy economic figures that are being bandied about. Since 2008, according to official figures, real GDP per head in both the US and the UK is up around 10%, but if we look at the median income – what the “average” person is experiencing – we see that these are down some 10% in the same period. The average person believes more in what they themselves are experiencing in reality rather than figures that are fed to them by some central body. As we said before, this is one of the reasons that the electorate has continued to surprise and confound those who are not so connected to “real” life.
Strangely, periods of stagnant or falling standards of living are historically accompanied by a booming demand for beauty products. Between the 1930 and 1933 Great Depression in Germany, Beiersdorf the cosmetics manufacturer did not have to lay off a single worker. The same was true in the US, in Japan throughout the past 25 years and most recently in Europe where the Continent’s largest cosmetics company, L’Oreal, has seen a dramatic rise in sales and profits.
The lipstick effect appears to be alive and thriving on both sides of the Atlantic. Since 2008, GDP in the UK is up some 10%, yet sales of beauty products are up almost 50%. In the US, total payroll employment is up 10%, but employment in the beauty and cosmetics sector is up 50%. It is difficult as an investor to get pure exposure to the cosmetics sector, but if this phenomenon continues, as we would expect it to in these times of uncertainty, it may be worthwhile exploring just that little bit harder to see if you can tap in somehow. If you can find a lippy manufacturer that suits you, it may make for an attractive opportunity.
Sources-BCA Research-April 2016
These are our views, as always, and don’t constitute advice in any way.
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