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Do Not Fear Inflation or Materially Higher Rates

Do Not Fear Inflation or Materially Higher Rates

By Wednesday, 09 March 2016 07:40 AM Current | Bio | Archive

It is human nature to never want to relive traumatic events. 

After all, who wants to relive experiences that have left deep, painful scars? On the other hand, if these traumatic events have a very low probability of reoccurring, then avoiding them can mean lost opportunity, which in the long run can be even more painful than wading in those same waters where the trauma was triggered.

A deep, indelible impact is felt by many who lived through spiraling inflation and skyrocketing interest rates in the 1970s and early 1980s. Those were perilous times that investors understandably do not want to relive.

This worry led many to sidestep a 30-year-plus bull market in bonds, or avoid taking more risk with their capital in the aftermath of the Great Recession for fear that interest rates would go through the roof due to quantitative easing by the Fed and large federal deficits leading to the re-emergence of inflation.

Investors wholived through the perilous '70s and early '80s and who were always looking over their shoulder for inflation and higher interest rates have been financially handicapped by their fears. Savvy investors who didn’t share the same trauma studied history and realized that the extremely high rate era was a once in a 200 to 400 year event ... 

Too many investors let their indelible fear of higher rates cloud their judgment and they paid the price in lost opportunity.

Our real estate investment and management firm has over $2 billion of debt financing supporting our portfolio of luxury apartments in areas that attract knowledge workers. 

History and experience has shown the benefits of having a large percentage of our debt in variable rate loans versus fixed rate loans. We’ve reaped the rewards from significantly lower interest rates, higher cash flows, and more pre-payment flexibility, unlike people unwilling to expose themselves to interest rate risk. Fixed rate financing has turned out to be expensive insurance.

Looking forward, I still believe that our emphasis on variable rate financing is the right strategy.

I do not fear inflation or materially higher rates, even though the Fed has now moved off its zero percent interest rate policy.

Here’s why:
  • Demographics – Unlike the 1970s, we have a much slower growing labor force and aging society in the U.S. This phenomenon is also global in nature and will continue to lead to excess savings hungrily looking for yield-oriented investments.
  • Globalization – Despite a slower growth in the global labor force, there is still expected to be stiff competition from around the world as technology enables developing countries to bring more products and services to market and employ more people productively. This should serve to keep labor’s share of national output at historically lower levels.  When combined with robotics beginning to come into practical use, worker insecurity will remain heightened and serve to emphasize the safety of saving versus confident spending.
  • Unions – The diminished role of unions should continue to serve to keep wage growth in alignment with productivity and much lower than it was in the unions’ heyday.
  • Financialization – The huge focus on shareholder value leads to borrowing to buy back stock and pay dividends versus being invested in wage-generating activities. The significantly higher debt burden in the economy since the 1970s makes it that much more vulnerable to higher rates leading to an economic contraction. Every major country that has raised rates since 2008 had to lower them subsequently because the economic cost was too high.
  •  Oil – The U.S. has shown that it can and will bring supply to the market if prices again become elevated, helping keep inflation at bay. Saudi Arabia is cognizant of this. This was not the case in the 1970s. The days of long gas lines are thankfully a thing of the past.
  • Innovation – Capitalism rewards those that can lower costs and prices, raise productivity, and enhance the consumer experience. There is plenty of private capital to back entrepreneurs and firms that successfully do this. Capital’s reach is global and technological innovation can allow for this on a dizzying scale, which creates a disinflationary bias.
Gary Carmell is the President of CWS Capital Partners, a real estate investment management firm based in California and Texas. To read more of his insights, click here now.

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I do not fear inflation or materially higher rates, even though the Fed has now moved off its zero percent interest rate policy.
rates, economy, investors, inflation
Wednesday, 09 March 2016 07:40 AM
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