The latest talk, and certainly the market mover of late June, was of “tapering.” This is the somehow frightful notion that the economy has legs and no longer needs to be propped up by accommodative Fed practices; low interest rates, bond buying, etc. Shouldn’t this be taken as good news?
When the fed begins to normalize its practices, and increases interest rates (read as “the price of money”), it’s a sign that the economy is starting to function properly, and businesses can function the way they were intended to.
For the financial sector, rising interest rates mean that banks will be more apt to lend. If you were a bank, and you believed that you could charge more for a loan tomorrow than you could today, wouldn’t you wait to make that loan? Today, banks are holding $1.7 trillion in excess reserves because it’s not as profitable to lend money today as it might be in the future.
This normalization will be good for other sectors as well. The economic downturn has forced across-the-board changes in the way businesses operate. Most businesses are coming out of this downturn leaner and meaner than they were when it started. Consider that workforces have been cut, loans have been refinanced at new lower rates, and processes have been optimized to maximize output while minimizing expenses. As a result we’re seeing a stock market which is reflecting this, with rising corporate profits and Price/Earnings ratios well in-line, or below historic norms. We believe stock values are real, and not a figment of Ben Bernanke’s imagination.
Don’t believe it? Look no further than your household as a microcosm of this phenomenon. In the past few years you’ve most likely refinanced your mortgage, from somewhere in the 5-6 percent range to, perhaps, 2.5 percent: businesses refinanced their debt, too. Maybe you’ve purchased a newer car, at a lower interest rate, which is more fuel efficient than the SUV you drove in 2006: businesses upgraded to more efficient equipment, too. When credit card companies became reluctant to extend credit, you probably paid down some of your balances: so did businesses. And, in the past few years maybe you fired your cleaning lady, started mowing your own lawn, re-roofed your own house, or cleaned your own gutters: businesses found a way to get things done with less help, too. The result of all of this is that your household, just like a business, is running more efficiently than it was before, and is ready to take advantage of future prosperity.
Tapering isn’t a dirty word—embrace it.
Stephen Kyne is a Partner at Sterling Manor Financial in Saratoga.
