Many of my columns as of late have been about rising U.S. interest rates and why I expect rates to rise further. Today, I’d like to briefly talk about the impact higher U.S. interest rates will have on different forms of investment, specifically stocks and real estate.
Money competes for only the highest and safest return. When interest rates fell so low in 2004, few investors were interested in buying T-bills because cap rates on investment real estate and dividend returns from utility stocks were simply more attractive. And both went up–real estate and utility stocks.
The landscape has changed drastically since mid-2004. The Federal Reserve has aggressively pushed up interest rates. I would not be surprised to see a Federal Funds Rate of five percent soon, up 400% since mid-2004.
As rates have risen, so have the yields on safe investments like U.S. Treasuries. A 90-day U.S. Treasury now pays 4.55 percent while a six month Treasury pays 4.69 percent– these are investments guaranteed by the U.S. government.
With rates expected to rise, will money be invested in investment real estate with unsecured cap rates of only six to seven percent? Not anymore. The alternative guaranteed T-Bills are too competitive. Will money go to the utility stocks? No, because the higher interest rates move, the lower utility stock prices will fall.
Again, capital always flows to the highest and safest returns. Right now, with interest rates moving higher, money has investment alternatives it didn’t have as recently as just a few months ago. I believe it will be difficult for big-cap mutual fund managers and big-cap stock portfolio managers to deliver returns this year in excess of what T-bills are paying. I also believe cap rates for investment real estate have fallen too low to be attractive anymore to investors. I’d think about selling both if I owned them.
NEWSFLASH-The estimate for first quarter U.S. Gross Domestic Product (GDP) continues to rise. Some analysts are actually predicting U.S. growth in the first quarter of 2006 (as measured by the GDP) to be around six percent. Growth above four percent will give new Federal Reserve Chairman Ben Bernanke the ammunition he needs to continue raising interest rates. Expect higher interest rates ahead.