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Is Zero the New Normal?
New York: November 23, 2009
By John Stephenson

Interest rates are ridiculously low as the U.S. Fed has kept the overnight rate at close to zero for months in a desperate attempt to reflate the American economy. Last year, when markets were tumbling and house prices imploding, the fear sweeping through Washington was that America could enter a deflationary spiral. While falling prices may seem like a good thing to consumers, it's a pretty serious problem for an economy. With falling prices, investment dries up. After all, who would want to invest today if prices tomorrow would be lower? Without investment, economic growth grinds to a stop, wages stagnate or drop and the party is over.

To fight deflation and get people spending and lending again, the Fed has done everything it could to encourage people to take on more investment risk. By lowering interest rates to such a painfully low level, the Fed has enticed investors to term out their short-term cash and put it in higher-risk bonds or stocks.

During the Great Depression, stuffing your mattress full of cash and hoping to break even seemed like investment nirvana. But today, with the U.S. dollar down 15 percent in the last twelve months against a basket of major currencies, just stuffing cash in your mattress doesn't seem so smart. Money market accounts, the modern day equivalent of the mattress are yielding almost 0%, yet there still is some $4 trillion stuffed in them. But that's beginning to change as disgruntled investors have been yanking $20 billion a week from these funds in search of higher yields.

Since March of this year, stepping out on the risk curve has paid off handsomely for investors. The stock market is up somewhere between 60 and 70 percent, gold is trading at more than $1,100 per ounce and oil is hovering around the $80 per barrel mark.

And with prices moving sharply higher for risky assets, many people are wondering if the Fed's low interest rate policy is creating the conditions for the next financial bubble to wash up on our shores. Perhaps!

But don't look for higher interest rates anytime soon. While a 60 percent rally in the market is great it still doesn't compensate for a 60 percent loss the year before. Investors are still out 36% of their money since this up, down, up crazy investment elevator ride began. And in the real economy the problems keep mounting.

Bank lending is still contracting, the private sector still hasn't taken the baton from government and started to spend and unemployment is still rising. There is just no way that Bernanke and company will be raising interest rates in the short run, with 15 million jobless Americans and another 25 million working part-time.

Not until investors' cash has gone into recapitalizing and revitalizing both the American homeowner and corporate America will the Fed even dream of raising interest rates to quash the mini asset bubbles that have been forming. The Fed funds rate is going to remain at or near zero until the economy really begins to turn, inflation reappears and GDP growth is a solid four percent or higher for at least a year before there is any move to reign in the growth.

As investors, do you begin to buy into the rally in stocks which yield just 2 percent on average and have already rallied 60 percent from their March lows? Or do you snap up investment grade corporate bonds and make a paltry 3 percent after fund fees, or instead, take your chances on high yield bonds where you might make a cool 8 percent but have to dodge the bullet of a potential corporate default?

The choices for investors are hard—take a more risky position in fast-moving stocks or suffer with near zero returns on less risky assets. Unfortunately, the prognosis for investors going forward is not looking all that bright.

The economy is likely to be anemic for a long time, government involvement in the economy is now the new normal and businesses, government and consumers will be paying down debt for the foreseeable future.

With government and consumers in hock up to their eyeballs, the prospect for a slow growing economy looks increasingly likely. And that economic restraint will slow investment, profits and payments to investors in the form of dividends and interest.

In a low growth environment investors have two choices—pick decent yielding investments that should grow along with the broad economy or take higher risk by looking abroad to regions of the world which are growing quickly. If a low growth capitalist model is America 's future, why not buy some utility stocks whose earnings growth should keep pace with the overall growth rates in the economy as they always have.

Best yet, utility stocks are trading half way between their 2007 peaks and 2008 lows, giving them a potential upside of 25 percent to their 2007 highs. Not only that, but utilities are offering dividend yields in the five to six percent range, rather than a paltry near-zero return on money market funds.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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