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Fear the GIC Refugee Renaissance

When I started in the business in September of 1993, it was a great time for new client acquisition.  The reason is simple: there were so many new clients to be had – in the form of first-time investors.  As interest rates plummeted from their all-time highs in the early 1980s, the fulcrum began to shift.  Specifically, as the risk-free rate (anything that could be attained on a guaranteed basis) dropped, people became increasingly willing to absorb risk.

 

Starting around 1982, the long-term macro trend that continues to this day began.  That year marked the cyclical high in long-term interest rates (in the mid to high teens!) along with a multi-generation low in price/earnings ratios (well into the single digit range!).  For nearly 40 years, interest rates have been seeing a secular decline, while market valuations the world over have been creeping up.  The correlation is predictable.  As rates drop, people are prepared to take on increasingly large amounts of risk in their quest for financial reward.  Totally understandable.

 

Now that rates are essentially at zero throughout the developed world, the trend has become acute.  The question that people might now be asking themselves is: will people stay out of traditional income investments for the foreseeable future?  If the answer is yes, the follow up question is: what will they do as an alternative?  The risk associated with interest-bearing vehicles (not only GIC, but also government bonds) may be essentially zero, but so is the expected return.

 

We’re in a brave new world now.  Stocks, as measured by various metrics such as price / earnings (P/E) ratios and cyclically adjusted ratios (CAPE) are in nosebleed territory.  The ratios have only been this high 4% or 5% of the time in recorded history.  Stated differently, if the highest readings are taken once a year, our current level is around what we might expect to see about once in a generation or so.  I’ve written about this before (see Bullshift Culprit #2 – TINA; Nov. 3) and the ongoing search for low-risk income-generating options is a hallmark of contemporary investing.  Here’s my worry: the only thing that’s worse than buying something that will not, under any circumstances go up is to desperately plow money into something that is riskier – meaning it could very easily go down.

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