By Tim Courtney, Chief Investment Officer
Over the past 15 years, since the end of the 2008 financial crisis, central banks (i.e., the Federal Reserve) have played a pivotal role in shaping markets through their monetary policies. Their primary tools for pulling markets out of a spiral were reducing interest rates and providing liquidity to banks. Initially, in response to the crisis, the Fed slashed the funds rate from around 5% to virtually zero in just over a year. This measure, coupled with the reversal of the mark-to-market rule, essentially stabilized the financial system and markets began to recover in 2009.1 However, this era of ultra-low interest rates had varied impacts across different asset classes.
In the equity markets, the performance of various sectors differed significantly. The lower rates had minimal long-term impact on value stocks, mid-cap and small-cap stocks; these assets generated returns very close to their 100-year averages.2 However, the growth sector of the market, particularly the largest growth stocks, almost doubled their long-term average returns - from 8-9% annualized to 15-16% annualized.2
In contrast, fixed-income assets like intermediate Treasury bonds and one-month Treasury bills (T-bills) suffered greatly. Their returns plummeted well below their historical averages3, with both lagging behind inflation. This was a direct consequence of the low-rate environment, which eroded the real purchasing power of investments in these assets.
Interestingly, all asset classes exhibited lower volatility compared to the previous 81 years.3 This reduction in volatility across both bonds and stocks suggests a more stabilized market less concerned with risk as the Fed was seen actively intervening.
The housing market was also active during this time. Despite some believing that low interest rates would make housing more affordable, housing costs escalated4. People were able to afford borrowing larger amounts and buyers bid up the prices of real estate all over the country – in both residential and office properties.
With interest rates returning to close to 5% today5, the Fed faces pressure to lower rates again. Lower rates might seem beneficial for asset owners and politicians as they can lead to increased valuations and easier borrowing, but it is far from clear that lower rates are a utopian solution. Lowering rates could trigger asset inflation without any fundamental health. This could lead to misallocations of capital and speculative bubbles, as we saw in 2021 when interest rates were at zero5, and phenomena like Dogecoin and meme stocks appeared in the market.
While low interest rates have provided boosts to certain asset classes during the last 15 years, the long-term benefits of constant economic stimulus is questionable. For bond investors, the erosion of real gains due to inflation has been realized. Homeowners and first-time homebuyers have faced increased challenges in affordability despite lower rates. This period also witnessed rampant speculation and misallocation of capital, driven by cheap money.
Our focus should remain on diversifying our investment strategies to ensure resilience in the face of policies and market dynamics that have been driven to extremes since 2008. If you have any questions, don’t hesitate to contact your Exencial advisor.
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Treasury bonds are fixed-rate U.S. government debt securities with a maturity of 20 or 30 years. Treasury bonds pay semiannual interest payments until maturity, at which point the face value of the bond is paid to the owner. T-bonds can be purchased individually.
Treasury bills (T-bills) are short-term debt obligations backed by the U.S. Treasury Department with a maturity of one year or less. T-bills can be purchased individually.