In Perspectives

In the years following the global financial crisis of 2007-2008, central banks around the globe led by the U.S. Federal Reserve took unprecedented steps to stimulate economic growth through exceptionally low interest rates and quantitative easing (QE) programs designed to push liquidity into the hands of individuals and businesses.  While the effectiveness of these programs will no doubt remain debatable for some time to come, the direct impact on savers and fixed income investors was unmistakable, as low interest rates pushed many conservative investors to take on more risk than they would like in order to find more attractive returns.

As the recovery has taken firmer hold in recent years, the Fed has looked to unwind these extraordinary measures and allow the economy to stand on its own feet, first by gradually tapering off QE and finally, in December 2015, by raising interest rates off the zero bound for the first time since the crisis. At that time, the FOMC announcement indicated that four additional interest rate hikes would likely be warranted in 2016, implying that we should have expected to see the next hike in Q1.

However, the stock market turmoil that erupted in the first quarter along with a patch of weaker than expected economic data has had many observers now considering whether any rate hikes were likely this year at all.   The sentiment has shifted for the better over the past few weeks, as financial conditions in the U.S. appear to have improved across the board with February’s jobs report showing strong gains and recent inflation measures ticking upwards.  Nevertheless, the Fed is unlikely to raise rates at their meeting this week, preferring to wait to see whether the recent readings prove consistent over the coming weeks and months.

Outside the U.S., economic conditions appear more tenuous, and central banks continue to take aggressive action.  Mario Draghi of the European Central Bank (ECB) last week announced a series of measures intended to further stimulate the European economy.  These measures included expansion of their QE program, offering very low-cost funding to banks in exchange for increasing lending, and pushing interest rates further into negative territory.  The Bank of Japan (BOJ) has also chosen a policy of negative interest rates, hoping to stimulate consumption and investment.

The upshot of these central bank policies at home and abroad is that higher interest rates are likely to remain elusive for the foreseeable future, and the struggle for fixed income investors to earn even modest returns may continue for some time.  Now that financial markets have calmed somewhat as we approach the end of the first quarter, we believe this is a prudent time for investors to revisit their financial goals with their advisors and reconsider strategic investment plans in light of lower return expectations over the next 3-5 years.

It may be appropriate for some investors to shift their focus solely from generating income toward seeking total return, which includes both income and capital appreciation.  Additionally, some alternative asset classes such as real estate investment trusts (REITs) and energy master limited partnerships (MLPs) typically pay higher income levels than traditional stock or bond investments and may be appropriate for inclusion as part of a diversified portfolio, as long as the investor can stomach the increased volatility.  Unfortunately the traditional trade off between risk and reward is still in play, and each investor will have to carefully consider whether taking on additional risk is warranted when seeking higher returns.   If you are concerned about meeting your financial goals in today’s challenging investment environment, we encourage you to reach out to us for an evaluation.