There has been a lot of talk in the investing town of late as to the probability of another 2020 market crash. That’s what tends to happen when share markets go for a run. And that’s exactly what global markets have been doing for the past six months or so. Since 23 March, the S&P/ASX 200 Index (ASX: XJO) has risen close to 30%.
Over in the United States, things are even hotter. The flagship US index – the S&P 500 Index (SP: .INX) – is up more than 51% since 23 March. And the tech-heavy Nasdaq Composite (NASDAQ: .IXIC) is even higher, up 61% over the same period. With so many investors sitting on some solid gains from these run-ups, there are no doubt some investors growing nervous about their new gotten gains.
And on one level, this is fair enough. Uncertainty still abounds. The pandemic is still with us. Economies around the world are still struggling with some of the worst economic conditions in a century. And we have a highly-watched and consequential US presidential election in less than two months’ time, which is bound to move markets whichever way the chips fall.
But I’ll be staying mostly invested in both ASX and international shares regardless, apart from a small cash position. Why? Well, firstly I think ASX shares are one of the best ways we can build wealth under any circumstances. Over the past 120 years, the ASX has continually moved higher and paid dividends and in doing so, has rewarded long-term investors with inflation-smoking returns. And that’s through the Great Depression, a multitude of wars, the global financial crisis as well as periods of both high inflation and low inflation. Because of this, I will always have at least some of my wealth tied to shares.
But secondly, it’s also because interest rates are at virtually zero. And that makes investing in shares more important and potentially more lucrative than ever.
Implications of a zero interest rate world
Interest rates aren’t just about low rates on your savings account alongside a cheaper mortgage. To explain this, I’ll draw on the wisdom of Warren Buffett, here provided by a Magellan Financial Group Ltd (ASX: MFG) website. Buffett here describes interest rates as ‘gravity’ on all other financial assets:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are, the less that present value is going to be. So every business by its nature … its intrinsic valuation is 100% sensitive to interest rates.
So with interest rates virtually zero around the world (0.25% here in Australia), there is almost no theoretical limit on how much of a premium investors can place today for income in the future (when interest rates might be higher than today).
And that means that investors are likely to continue to pay high prices for shares until rates rise, regardless of the normal ebbs and flows, ups and downs, of the share market. It doesn’t hurt that there are few other real options for yield in a low-rate world either. That means I’ll be investing in shares at full-throttle until rates start going up again. Perhaps you should too!