How to benefit from fiscal dysfunction in Europe, Japan

Negative interest rates are the latest central bank scheme to rejuvenate moribund economies in Europe and Japan. It’s not going to be any more successful than their previous stimulus attempts.

The reason: Without fundamental changes to fiscal policy in the euro zone — in particular, lowering its high taxes and easing restrictive labor laws — there can be little progress in spurring economic growth.

What’s the JGB yield curve signaling?

The yield curve suggests that BOJ’s tiered rates system is working to driving yields lower and increasing credit spreads, notes ANZ’s Richard Yetsenga.

Similarly, the Japanese government imposed a big tax increase that stifled its economy. Depending on monetary policy alone is like trying to fly an airplane with just one wing. To make the price of money negative goes against the normal course of economics.

With negative rates, central banks charge financial institutions a fee to store their money; the normal practice is to pay the lenders interest. The theory is that the less-than-zero approach will make commercial banks more eager to expand loans to businesses and consumers, and those loans still carry positive rates.

Some bonds the public holds, however, sport negative yields, which is supposed to encourage the people to spend, thus juicing growth.

Advisors, investors off mark on risk tolerance

But charging negative rates hasn’t proved to be the elixir the central banks sought. The European Central Bank imposed negative rates in 2014, and yet the region still shows sluggish growth. This follows an enormous ECB program to buy bonds and other financial assets, in a bid to pump money into the economy.

The Bank of Japan pushed its rates into negative territory in January after similar disappointing results with bond buying.

The failure of the central banks’ theory is stunning. In Europe and Japan, corporate balance sheets are awash in cash. Individuals prefer to pay down debt rather than to go on spending sprees.

“If you are looking for a commodity that has scarcity going for it, think about collecting $100 bills. There’s a movement afoot in international financial circles to do away with them.”

Also, negative rates were supposed to make European and Japanese currencies cheaper versus the American dollar and buoy their exports to the United States. That didn’t happen: The euro and the yen strengthened. Plus, stock markets in Europe and Japan have sagged, a vote of no confidence.

What does all this monetary dysfunction mean for U.S. investors? Note that Federal Reserve Chair Janet Yellen does not show a lot of sympathy for plunging rates below zero. Her plan is to continue raising short-term rates, although not at the pace the Fed originally envisioned. The upshot is that a lot of flight money, particularly from Europe and Japan, will head for American shores in the months ahead.

Here are three strategies to take investing advantage of the situation:

Is it time to ditch the 60/40 rule?

1. Stay fully invested, and snap up cheaper stocks in Europe and Japan. Monetary problems in those nations, in addition to China’s growth slowdown, are no reason to pull back.

The Japanese stock market is down some 10 percent this year. Bourses on the European continent are offering good bargains on prime stocks. If you don’t want to own individual shares, buy good mutual funds and exchange-traded funds that focus on their stock markets. While the dollar is off this year, it remains stronger than it was three years ago, which enhances your purchasing power.

2. Buy U.S. investment-grade corporate bonds. It’s unclear how negative rates on the other side of the Atlantic and Pacific will affect corporate debt over there. In any case, their credit markets have nowhere near the size and liquidity of U.S. ones.

Could the Fed introduce negative interest rates?

Negative rates in the U.S. is unlikely scenario because the U.S. is in a much stronger economic position, says San Francisco Fed’s John Williams.

What’s likely is that high-grade domestic corporate bonds will pay increasingly better yields. That’s because flight capital into safe Treasury bonds will pump up their prices and drive their yields down (prices and yields move in opposite directions).

The yield spread between Treasury paper and corporates has widened considerably over the past year. Buying U.S. junk bonds, which pay richer interest, is not a good idea when the landscape is so turbulent.

3. Put a small amount of your portfolio into gold. If your confidence in currencies is shaky, gold is a traditional refuge. The price of gold, which soared on the heels of the financial crisis, tumbled after 2012; amid current worries, though, it is edging up again.

Volatility drives retirees to annuities

This year, bullion is ahead some 16 percent. Gold can be a volatile commodity, of course, and pays no dividends. But you can easily buy gold coins and store them in a bank safe deposit box.

And if you are looking for a commodity that has scarcity going for it, think about collecting $100 bills. There’s a movement afoot in international financial circles to do away with them, as well as 500 euro bills and other such lofty denominations, on the grounds that terrorists and criminals use them.

While Europe and Japan’s central banks may falter in their financial plans, you can prosper in yours.

— By John E. Maloney, chairman and CEO of New York-based advisory firm M&R Capital Management


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