There is something both quite scary and interesting happening these days on the market: the direction of interest rates. Regardless if you are living in the US or in Canada, you are currently getting the deal of the decade (or the century?) in terms of low interest rates. If you borrow for a mortgage, nobody will mention rates around 5% or 6%. Depending on the term, you will be looking at a 3% to 4% interest rates. And if you are looking short term, you can even get below 3%!
Since 2008, the direction of interest rates has gone straight to h?ll. This is because our countries can borrow at very cheap rates and our central banks (the FED and the Bank of Canada) want to keep interest rates low in order to stimulate the economy. Since internal growth is still weak, low interest rate policies are here to stay a little longer. The FED already announced that they would keep their rate policy if effect until 2014 (which was originally until 2013 and previously until 2012…).
This has obviously helped a lot of families that currently run a tight budget. We often hear that a 2% rise in the interest rate would completely change our economy and that we would see foreclosures surging all around North America. For example, the monthly payment on a 400K mortgage over 25 years at 3.75% is $2,050. If you change the interest rate to 5.75%, you get a boosted payment of $2,500.09. That’s $450/month more! Do you know a lot of families that are currently saving over $450 for rainy days on top of their budget?
What Would Happen If You Have To Borrow at 7%?
I know… you are probably thinking that interest rate won’t go up like this and thinking of a catastrophic scenario showing interest rate at 7% is crazy. Think again. You can’t imagine your mortgage going up to this rate and have no idea where you would get the money to make your payments. This is not a fun scenario and we tend to ignore it or discredit it simply because we have to say that we would lose our properties if it happens. Well there are people in this situation and it may be not the ones you think…
Current Borrowing Rate in Spain Just Hit 7% at the Beginning of the Week
On Monday June 18th, Spain 10 year bonds were at 7%. Just to put everything in perspective, Spain is the fifth largest economy in Europe and twelfth largest economy in the world in terms of GDP. From 2000 to 2008, Spain was one of the best economies in Europe. But since 2008, things went sour and Spain is now showing a 25% unemployment rate. Since this wasn’t enough, they now have to borrow at 7% because investors are afraid that Spain is right behind Greece in the bailout line-up.
Is it normal that we, as individuals, can borrow an interest rate 50% smaller than the 12th world largest economy? Can they find a way out to pay down their debts while 25% of their source of income (workers paying taxes) are not producing any? Worse than that; they are not only producing $0 income in taxes but they cost something since they are being financially supported by the government. If I was Spain and my mortgage rate was at 7% and would lose 25% of my income, I would definitely have to call The Mom & Dad Bank for a bailout!
What Kind of Impact it Can Have on The Stock Market?
There is good news and bad news related to this situation. The good news is that we are set for low interest rates for a while still. This is also good news for companies who can borrow at very cheap rates and generate more income through growth. The bad news is that growth may not come very fast! What happens when you go through a challenging financial moment? You cut your expenses and seek additional sources of revenues. When you are a Government, it’s called: applying austerity measures. You cut in services and increase taxes where it’s possible.
In such an environment, investing is quite a ride. You have the choice between picking bonds that don’t pay or stocks that will go down in value. In both cases, it’s impossible to generate an interesting yield from your portfolio. What’s the solution? Picking stocks that are cash rich. Your stocks will still go down in value but you know that these companies will survive and grow stronger from such a situation. In the meantime, you may as well get a few dividend payouts ?.
Where do You Start?
As a reference, I’ve compiled a few good articles that will help you chase down the right stocks to make it through this heavy environment:
Top websites for stock research
15 things I look before trading a stock
Where to find Dividend Growth Stocks
Cash is king they say. Senior companies with positive cash flows can weather any kind of recession better than most other businesses. Just have to keep a long term investment outlook.