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What if interest rates stay low forever?

As all investors would (or at least should) know, interest rates are at record lows, both in Australia and across the advanced economies of the world. This has had some interesting effects on the ASX that have become apparent throughout 2019 so far.

But according to the Australia Financial Review, this could actually be the new ‘normal’ for our economy – driven by demographic changes and risk and reward calculations.

As our population ages and there is less labour market participation, the level of saving will likely increase throughout the economy. This will also be accompanied by a higher demand for less risky assets such as bonds and cash instruments as retirees typically have less appetite for risk. Both of these trends will likely see increased downward pressure on interest rates for the foreseeable future.

This isn’t too difficult to contemplate – Japan has been dealing with low or negative interest rates for decades now, and bond yields in many European countries are also currently negative.

And if the Reserve Bank of Australia (RBA) undertakes a program of quantitative easing down the road, which is unlikely but not impossible (according to the RBA), this will only amplify these trends.

What will this mean for ASX investors over the next few years?

It’s likely that shares will continue to be revalued higher and higher. Most valuation methods for stocks rely on what’s known as a ‘risk-free rate’ – this is typically what an investor can expect from a government-issued bond (a risk-free investment). If interest rates stay low, the risk-free rate will also remain low, pushing up the valuations of other ‘risker’ investments like shares.

Shares that offer large or stable dividends like Transurban Group (ASX: TCL), Sydney Airport Holdings Pty Ltd (ASX: SYD), Goodman Group (ASX: GMG) and Commonwealth Bank of Australia (ASX: CBA) will be particularly affected. Some of these shares are already known as ‘bond proxies’ as they are the ‘safest’ high-yielding assets outside the government bond market and their appeal will only increase over time if rates stay low.

Foolish takeaway

Despite the major markets shifts that are likely if rates stay low, I think that if investors stick to core investing principles and look for high-quality companies, things will work out fine. Chasing yield for yield’s sake is a more dangerous path, as is chasing hot growth stocks just to get above-market returns. The middle path is a well-worn, but steady road in the end.

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Motley Fool contributor Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited and Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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