Friday, October 18, 2019
There's no precedent
The day-to-day stories driving financial markets are well-known at this point. Recession fears, trade fights, Fed action, impeachment. But in his latest memo, legendary investor Howard Marks tackles a subject that appears to be giving the institutional investor class anxiety: negative interest rates.
Sure, Marks says, we know what negative interest rates are: a bank charges depositors to keep their money at the bank instead of offering interest payments.
As for why negative rates prevail in some economies today, no fewer than a dozen reasons are offered by Marks and colleagues he discussed this memo with for why negative rates exist today. It’s a reason Marks writes that “no one should feel the reasons for negative rates are fully understood.”
“The fact that we know what [negative rates] are,” Marks writes, “doesn't alter the fact that we don't know for sure why negative rates are prevalent today, how long they'll continue in force, what might cause them to turn positive, what their consequences are, or whether they'll reach the U.S.”
Defining a term means nothing if what you are defining doesn't really make sense. It's just a collection of words.
Now, if there is one thing that financiers believe to be definitely true it is that money lent to a counterparty will be returned at some point in the future, with interest. But negative rates suggest that this always-and-everywhere truth may not, in fact, hold.
And the overarching message of Marks' memo is that negative rates seem to break the brains of many investors he reached out to in the process of putting together this piece. For instance, Marks outlines more than 10 different ways that negative rates turn the basic assumptions of financial modeling upside down.
As Marks notes, “in the financial world, most of our actions are based on the assumption that the future will be a lot like past.”
“Positive interest rates and the desirability of compounding [interest] have been among the most fundamental historical building blocks [in finance],” Marks writes. “At a minimum, negative rates mean there's increased uncertainty, and thus we have to proceed with more trepidation. Whatever we knew about the past about how things worked, I think we know less when rates are negative.”
Negative rates, in other words, are a classic known unknown. We know what they are. We don't really know what they do.
And though investors always hate uncertainty, negative rates that break traditional financial models and short-circuit the Excel file are a bridge too far for some.
What to watch today
10 a.m. ET: Leading Index, September (0.1% expected, 0.0% in August)
6:55 a.m. ET: Coca-Cola (KO) is expected to report adjusted earnings of 57 cents per share on $9.43 billion in revenue
7:30 a.m. ET: American Express (AXP) is expected to report adjusted earnings of $2.02 per share on $10.94 billion in revenue
8 a.m. ET: Kansas City Southern (KSU) is expected to report adjusted earnings of $1.79 per share on $734.33 million in revenue
Pound hovers at 5-month highs ahead of crunch Brexit deal vote [Yahoo Finance UK]
Saudi Aramco to delay launch of its IPO [Bloomberg]