Greek Debt, interest rates key investment questions

The stock market, after having done virtually nothing during all of 2011, has done well so far in 2012. In January, the S&P 500 advanced 4.36 percent and by mid-February the index was up another 2.2 percent, bringing the year-to-date price change to 6.7 percent.

If this trend continues for the remainder of the year, stock returns could be up big in 2012. However, this is always a dangerous assumption. We should be asking ourselves, “What’s going on?”

The Federal Reserve Open Market Committee made a statement in January that it had no intention of raising interest rates until late in 2014.

That was the first time that the Fed had ever put a date on how long it would keep rates at a certain level. This seems to have given a green light to anyone willing to speculate on rates staying low for the next two-plus years. In other words, those willing to borrow at low short-term rates and lend at higher long-term rates see the Fed statement as a guarantee of profits for at least two years.

With profits seemingly guaranteed for the next two years, investors have jumped into both the stock and bond markets, driving prices higher and, in the case of bonds, yields lower.

Price/earnings ratios for stocks also are on the rise, a sign that stocks are not as inexpensive as they were just a few months ago. This is easily explained.

Money market funds yield 0.2 of a percent. Five-year Treasury notes yield 0.65 of a percent. Ten-year notes yield 1.8 percent.
But you can find stocks that yield 3 percent, and they have a chance at providing some capital appreciation, as well.

The Fed’s low interest rate policies have forced the average investor to assume more and more risk in an attempt to try to earn any sort of return on his investments. Meanwhile, debtors are being rewarded with the lowest interest rates in history.

In defense of the Fed policy, it can be argued that the recession that began in 2008 was so severe that it required a more-than-normal response. Indeed, it was the most severe recession we had experienced since the Great Depression.

Low interest rates allowed the banks to earn their way out of the problems they encountered. The banks have recovered and shouldn’t need this type of support now.

I miss the days when a Fed chairman thought his job was to mitigate economic volatility, both to the upside and the downside.
It seems that for the past 25 years, the Fed’s main concern has been to keep the economy moving forward, no matter what it takes or what the cost. Such policies guarantee that each succeeding crisis will be worse than the last.

Fed policies are not the only headwind facing economic recovery. Federal government spending is another problem. Our government has been spending money like drunken sailors in an effort to stimulate our way to some sort of an economic recovery.

In addition to the U.S., governments around the world have been spending far more money than they receive in tax revenues and making up the difference by borrowing.

Think about this for just a minute: In spite of the fact that governments around the world are heavily indebted, interest rates are the lowest they’ve been -- ever.

Today, we have governments around the world in more debt than they’ve ever had, but paying interest rates that have been engineered by central banks around the world to be the lowest in history.

The exceptions to this are the “PIGS of Europe,” which are Portugal, Ireland, Greece, Italy, and Spain, each of whom is paying higher-than-market interest rates because of the perceived risk of default on their bonds.

The sad truth is that many other countries, including the U.S., are not far behind the PIGS when it comes to debt accumulation. If these debts are not addressed soon, in a few years we could be facing similar problems. At that point, there won’t be any good choices from which to choose, only a choice among bad ones.

The markets should be concerned about the run-up in both the stock and bond markets because the return one gets on an investment is dependent on what one pays for that investment. If an investor overpays, poor returns usually follow. We remain cautious on both the stock and bond markets.