Don’t abandon stocks amid rising market risk

<p><strong>Glenn Freeman</strong>: In this edition of "How We Invest Your Money?" I'm speaking to Hugh Giddy, who's a Senior Portfolio Manager with Investors Mutual.</p> <p>Hugh, thanks very much for your time today.</p> <p><strong>Hugh Giddy</strong>: You're welcome.</p> <p><strong>Freeman</strong>: Now, Hugh, interest rates are at historic lows at the moment. What does this actually mean for investors?</p> <p><strong>Giddy</strong>: The reason interest rates are so low is because growth is quite weak. Although, interestingly, if you look at unemployment, it's low in the U.S., it's pretty low in Australia. The reason it isn't lower is there's more participation in the labor market. But if you think about why interest rates are low, it's because central banks have lowered them. Now, Australia has lowered them along with our central banks. But in free market economies, interest rates is one of the things where the price is actually controlled by the government. It's not a free market. It's not a capitalist system in full because interest rates aren't set by the market, they are set by central banks.</p> <p><strong>Freeman</strong>: So, it's not something that happens by mistake or just by pure virtue of the market?</p> <p><strong>Giddy</strong>: It's not the guiding hand of the market, sort of, of Adam Smith. It's the government says we want to interfere. And people don't challenge that consensus that much. And they tend to believe and there's this belief that lowering interest rates stimulates growth. So, asset prices have gone up a lot because of the low interest rate environment. But that only benefits really the rich who own assets. If you don't own assets, if you are poor, you've been left behind. And so, that's why you got a lot of the social discontent where people look at the inequality. In the U.S., it's very extreme, but in Australia, I think the inequalities is quite significant because asset owners have benefited at the extent to the detriment of people who don't really own assets. You think of young people who want to buy a house, it's a struggle, because house prices are very high in Australia. And it's interesting, if you go back in time, the last time that income inequality and wealth inequality was so large was actually in the late 20s, at the time of the of the crash and the Great Depression.</p> <p>I was at a dinner on Tuesday, the Australian Business Economists dinner where the Reserve Bank Governor of Australia, Philip Lowe, was presenting and he acknowledged that low interest rates keep companies alive, zombie companies who would otherwise maybe go bust and that creates competition for people who are making money and have a solid balance sheet, but that also keeps the price down. But one of the things he was talking about was the inflation target, which in Australia is between 2% and 3%. And he was asked about the inflation target and he dodged the question, he just said, "Oh, I met with Josh Frydenberg, the treasurer, and we agreed on the contract of monetary policy and the inflation target. The fact that they agreed on it doesn't mean that it's the right target. And I think that target was set a long time ago when inflation was quite high, when inflation was in the double digits, 15% 17%, then it seems fantastic. If we can only get inflation under 2% to 3%, bonza, that's fantastic. But now, inflation is below 2% to 3% and why should we be trying to get it up? What is the benefit of higher inflation? It's not clear to me. 2% to 3% means prices will double in 25, 30, 40 years depending on the rate of inflation. Is that a good thing? Why should we have that? And nobody's really offered an explanation why zero inflation isn't a decent thing.</p> <p><strong>Freeman</strong>: And obviously, that lever of interest rates is one thing that central banks will pull on. They're trying to do this to get consumption to pick up and to get inflation to pick up, but it hasn't worked, has it?</p> <p><strong>Giddy</strong>: Well, you think about it, -- you know, if interest rates are very low, it's partly growth is low. So, maybe you've got less to pay on your mortgage because of the lower interest rate. Do you use, "oh, let me guard and spend." Now, you're sort of a little bit worried that, well, A, you might not be getting a salary increase anymore because inflation and growth are low. B, maybe you're going to lose your job because we've had an expansion in Australia since 1991, which is a very long period of time. And there are signs of vulnerabilities in the economy. So, maybe, you know &ndash; and you also are under a mountain of debt. We've got one of the highest household debt levels in the world. So, maybe when interest rates go down, and people are doing this, you pay off some of your debt. So, you actually haven't seen a rise in consumption. And interestingly, in in Europe, where interest rates are even negative, they have found that the savings rate has actually gone up instead of simulating consumption. Why? Because people are thinking, "Well, I'm going to stop working and retire some day and I'm going to have to save more because look at these dreadfully low interest rates. So, it's actually having the reverse effect. It's not having an effect or the intended effect. Cutting the interest rates is actually hurting spending.</p> <p><strong>Freeman</strong>: But how should sort of more conservative investors think about how they're investing now in this lower rate environment?</p> <p><strong>Giddy</strong>: Well, it's an interesting thing. Obviously, cash is very unpopular, because it earn such a low yield and people are used to earning rates on term deposits of maybe 5% or 6%. We believe, and I believe that as far as equities go, you obviously do take on more risk because the stock market is volatile, it is going to go up and down. But within the stock market, you should invest in quality, solid defensive companies that you feel confident are going to be around and in a better state in five years' time. If the companies are speculative and being driven by the sort of mania for assets that aren't cash, then trouble could lie ahead. But if they're solid companies that generate steady cash flows, sure they will go up and down, but in five years' time, you will probably not have done too badly.</p>