The fact that at global level the interest rates of the main central banks are at the same time at almost zero and\/or negative level is clearly due to a high degree of surplus liquidity that exists globally. In addition, due to these very low and\/or negative interest rates indicated that a concerted effort is being made by the main central banks of the planet to direct and induce a continuous flow of investments in order to support the growth rate of the global economy.<\/p>\n\n\n\n
![\"\"](\"https:\/\/www.liberalglobe.com\/wp-content\/uploads\/2019\/09\/US_Federal_Reserve_Eccles_Building_1937.jpg\")
Photo by Author: Federal Reserve , Source: 00491
licensed Public Domain, https:\/\/en.wikipedia.org\/wiki\/Public_domain<\/figcaption><\/figure><\/div>\n\n\n\n
In this concerted effort began to enter from yesterday and the FED with the reduction of its basic lending rate from 2,25% to 2%, announcing at the same time its CEO that if necessary the FED will implement a series of reductions in its interest rates with aim to support the global economy.<\/p>\n\n\n\n
On the other hand, at global level there is increased investment hesitancy\nfor risk-taking, mainly because of trade and monetary wars, geopolitical\ndevelopments and oil price turmoil, indicating that the efforts by the central\nbanks have so far not been given the desired results.<\/p>\n\n\n\n
The negative consequences of the low\/negative<\/strong> interest rates<\/strong><\/strong><\/p>\n\n\n\n In a world characterised by investment hesitancy, negative interest rates affect:<\/p>\n\n\n\n 1.<\/strong> Saving in all its forms. This is because savings in an environment of negative and\/or zero interest rates pose risks to depositors\/savers because savings funds cease to be productive for depositors. The accompanying risk level in savings is a component of the size of the savings capital, the expected yield, the duration of the savings, etc.<\/p>\n\n\n\n 2.<\/strong> So, given the above consistency (1), most people will pull out their savings and try to direct them to other types of investments in the main direction to the housing market because the property as an investment includes the lower investment risk.<\/p>\n\n\n\n Due to the constant flow of funds from savings to the real estate market, property prices over time will increase. In this way, the profit that will be achieved by the monthly installment of the mortgage loan due to the negative borrowing rates will be vanishing due to the need for higher borrowing amount (due to increased property prices) or will be required higher amount of funding from the borrower’s own resources.<\/p>\n\n\n\n 3.<\/strong> The deposits by companies in banks will be punished with varying charges which over time will increase. In future the same will happen in the deposits of individuals. The aim of this “punishment” is for companies to pull out their funds and invest them. Investments, however, due to the high risk in the world level, reduce the size of actual yields.<\/p>\n\n\n\n How asset yields are used as an investment selection criterion<\/strong><\/strong><\/p>\n\n\n\n Each financier and more generally each investment advisor knows that the\nbasic criterion of an investment either this investment takes place in\nstock markets or in the capital markets or in the real\nestate markets or in the market of business, etc. is that “the asset \nprices should equal \nthe expected discounted \ncash flows”.<\/p>\n\n\n\n This is the basic principle that determines whether a market is efficient,\ngiven that the efficiency of a market is based on whether its prices and\nincorporates correctly in the asset prices all the new information related to\nfuture cash flows of these assets.<\/p>\n\n\n\n At the same time the expected discounted cash flows indicate the risk\npreferences of investors. Having always as a guide this basic principle that\nis, \u00abthe asset prices should equal the expected discounted cash flows\u00bb can be said: <\/p>\n\n\n\n However, the present value of these expected cash flows depends on the\ndiscount rate (which shows the risk profile of each investor) which the\ninvestors apply in the valuation of future cash flows (earnings).<\/p>\n\n\n\n In the field of business investments\/projects this discount rate is the\nweighted-average cost of capital (please, see the glossary). This discount\nrate, which is different in size due to what each investor believes for the\nfuture, is the basic explanation of the volatility of stock prices.<\/p>\n\n\n\n In this way, if the stock prices are high and the yields are low the investors can accept lower-level returns in the future and vice versa. In other words, the yields are the mechanism to predict expected returns on assets.<\/p>\n\n\n\n How accurate<\/strong> is the predictability of\ngovernment bond yields<\/strong> in terms of expected returns<\/strong><\/strong><\/p>\n\n\n\n To answer this question, we should check:<\/p>\n\n\n\n 1.<\/strong> The actual annual performance of government (Treasury) bonds by looking at their historical figures and then we should compare this performance in relation to the yield-to-maturity that It arises respectively from the index-linked Treasury bonds.<\/p>\n\n\n\n 2.<\/strong> Expected cash flows from stocks do not present the same degree of certainty as the corresponding expected cash flows from government bonds. That is another reason of why government bonds are generally characterised as the safest investment in transferable securities.<\/p>\n\n\n\n 3.<\/strong> High stock prices relative to dividends, have indicated many years of poor returns. Low stock prices relative to dividends, have preceded high returns. <\/p>\n\n\n\n To properly predict stock returns as well as the dividend yields the\nvaluation method, we will have to use on the stock will be based on the\ncompany’s aggregate earnings or book value.<\/p>\n\n\n\n But here it needs attention because many companies use the share-buy-backs\nstrategy to return funds to their shareholders instead of paying dividends. For\nthis reason, many investors use the earnings yield as a tool for forecasting\nstock returns. <\/p>\n\n\n\n This is because many companies do not use their company’s earnings to distribute capital to their shareholders in the form of dividends or share buy-backs but they reuse them by investing them in the company itself in order to create rapid growth in the company and greater future growth of earnings.<\/p>\n\n\n\n 4.<\/strong> The successful investor is characterized by the fact as to whether it achieves accurately to predict when it should sell at high prices assets and buy back assets at low prices. In other words, if he is successful to catch turning points profitably.<\/p>\n\n\n\n Therefore, if yields predict returns, then the investors can sell stocks\nwhen yields (expected returns) are low and buy stocks back when yields\n(expected returns) are high. But in practice, this type of forecast-signal does\nnot work well. <\/p>\n\n\n\n If the investor is short runner in terms of profits, he will try to use this tool of profitability turning points. <\/p>\n\n\n\n If the investor is long runner in terms of profits, he will interest how much extra cash the stocks will return to him over the safe investments (government bonds) in the long run. <\/p>\n\n\n\n 5.<\/strong> This extra cash (extra reward) in the long-run over the safe investments is indicated by the Equity risk premium-the discount rate. In other words, the equity risk premium is equivalent with the expected return on equities. This risk premium for US equities is given by the following equation.<\/p>\n\n\n\n Equity risk premium = S&P 500 earnings yield \u2013\nreal 5-year Treasury Bond yield<\/em><\/p>\n\n\n\n To estimate the equity risk premium for an individual\nstock you must replace the S&P 500 earnings yield in the above equation with\nthe individual stock earnings yield. <\/p>\n\n\n\n The higher the risk premium on stocks, there are more probabilities that\nthe investors to decide to tilt their portfolios away from government bonds and\nvice-versa. <\/p>\n\n\n\n Those investors which have a long-term perspective on their investments\nmight find more profitable to use this measure-tool (equity risk premium) in\norder to construct an investment portfolio based on a mixture of risky stocks\nand government bonds (safe investments) and a percentage in cash. <\/p>\n\n\n\n The housing markets<\/strong><\/p>\n\n\n\n The same approach can be used in the real estate market. Specifically, when the demand for housing is strengthened, the rents are reinforced respectively (in this case the rents and the sale value of property are the expected returns from an investment on property). <\/p>\n\n\n\n The main reasons for boosting demand are, long-term maintenance at low\nlevels of borrowing rates, increased employment rate and population growth due\nto internal or external migration.<\/p>\n\n\n\n The housing market for the purpose of its exploitation through rental is a\npopular investment activity that pays off when bank lending rates are low and\nthe returns from the financial markets are uncertain.<\/p>\n\n\n\n When the real-estate market is depressed and it is difficult to sell, it is\nquite difficult to rent. When the real-estate market is on growing market prices and it is easy to\nsell, it is easier to rent. <\/p>\n\n\n\n The yield of the property through its rental is determined by the following\ntype:<\/p>\n\n\n\n Yield of the property = [(Income from rental \u2013 property expenditures \u2013 taxes)\/ Value of Property] x 100%<\/em><\/p>\n\n\n\n This yield of property is used to compare with the returns (yields) of\nother types of investments from stocks, government bonds, etc. This yield of\nproperty which comes from rental activity looks very much like the interest\nrates that Banks and Building Societies used to quote in savings and\nperformance accounts equally and other type of investments etc. and gives a\nuseful insight into the return on investment. <\/p>\n\n\n\n In order an investor to evaluate in the long-run the extra cash (extra reward) over the safe investments (government\nbonds) he must use the Real estate risk premium-the discount rate. In other\nwords, the real-estate risk premium is equivalent with the expected return on property.\nThis risk premium for US real estate market is given by the following equation.<\/p>\n\n\n\n Real estate risk premium = MSCI REIT index total return \u2013 real 5-year\nTreasury Bond yield<\/em><\/p>\n\n\n\n To estimate the real-estate risk premium for an individual property you\nmust replace the MSCI REIT index total returnin the above equation with\nthe individual property yield (estimated in the above formula). <\/p>\n\n\n\n The higher the risk premium on properties, there are more probabilities\nthat the investors to decide to tilt make an investment on properties and away\nfrom government bonds. <\/p>\n","protected":false},"excerpt":{"rendered":" In EU member countries (e.g. Denmark, Germany) commercial banks are proceeding to mortgage loans with a negative lending rate. In other words, these banks…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[5,961],"tags":[1053,1051,1056,1055,1058,1050,1052,877,425,1049,874,1048,1059,1054,2191,1057,948],"class_list":["post-1214","post","type-post","status-publish","format-standard","hentry","category-economic","category-financial-economics","tag-bonds","tag-depositors","tag-discount-rate","tag-dividends","tag-equity-risk-premium","tag-global-economy","tag-housing-markets","tag-interest-rates","tag-investment-risk","tag-investments","tag-mortgages","tag-returns-on-assets","tag-sp-500","tag-stocks","tag-trust-economics","tag-volatility","tag-yields"],"_links":{"self":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/1214","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=1214"}],"version-history":[{"count":5,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/1214\/revisions"}],"predecessor-version":[{"id":3652,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=\/wp\/v2\/posts\/1214\/revisions\/3652"}],"wp:attachment":[{"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=1214"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=1214"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.liberalglobe.com\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=1214"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}![\"\"](\"https:\/\/www.liberalglobe.com\/wp-content\/uploads\/2019\/09\/1976_5000_825_Treasury_Note.jpg\")
Photo by Author: J. Herbstman, licensed Public Domain
Source: The Joe I. Herbstman Memorial Collection of American Finance
https:\/\/en.wikipedia.org\/wiki\/Public_domain<\/figcaption><\/figure><\/div>\n\n\n\n![\"\"](\"https:\/\/www.liberalglobe.com\/wp-content\/uploads\/2019\/09\/320px-Bignor_cottage.jpg\")
(Bignor Cottage, West Sussex, England)<\/strong>
Author: Charlesdrakew, Source: Own work, licensed Public Domain
https:\/\/en.wikipedia.org\/wiki\/Public_domain
<\/figcaption><\/figure><\/div>\n\n\n\n