Is there a chance that interest rates will never go up?
Is the world — including Australia — in a new era of permanently low interest rates?
In fact, it’s probable.
Importantly, if interest rates stay low, what will it mean for you?
First, how can we say interest rates will stay low?
You’ve probably seen and heard press reports that interest rates will have to go up soon.
They especially won’t go up if Australia’s wages growth stays in the toilet.
Take this report from yesterday’s Sydney Morning Herald:
‘Families are expected to cut spending further as wage growth plunges to its lowest in 17 years.
‘Wages have risen 2.6 per cent in the past year, according to Australian Bureau of Statistics data released on Wednesday.
‘That rate is now below the consumer price index — which puts inflation at 2.9 per cent — and is the weakest reading since the records began in 1997.’
We’ll just explain what that means. When wages growth is lower than inflation it effectively means wages have fallen.
It means the average Aussie’s cost of living has risen and their standard of living has fallen.
In that scenario, and considering that roughly one third of Aussie households have a mortgage, can you really imagine that the Reserve Bank of Australia will do anything that would cause the cost of living to rise further?
Not a chance.
We know that because this is exactly the same thought process the boffins at the US Federal Reserve are going through now.
The US Federal Reserve knows it can’t ‘shock’ the US economy by raising interest rates too soon. As Reuters reports:
‘”My current thinking is that the pace of tightening will probably be relatively slow,” [New York Federal Reserve President William] Dudley told a group of business economists in New York. He also reiterated that the central bank would wait a “considerable time” after winding down its bond-buying stimulus program before raising rates from near zero.’
The market expects the Fed to end its bond-buying program in October. So a ‘considerable time’ after October is…when?
It won’t be before the end of this year. And odds are it won’t be before the end of next year. In fact, our bet is that interest rates won’t go up at all.
Remember, the US has had zero interest rates for nearly six years. By the time the US Federal Reserve is even in a position to think about raising rates it will be nearly seven years.
Compare that to Japan, which has effectively had zero interest rates for nearly 20 years.
What makes anyone think the US will be any different? And although Australian interest rates may not sink to zero, it’s tough to see them reverting to so-called ‘pre-crisis’ levels of 4% and above.
As long as the unemployment rate is relatively high, and as long as the federal government needs to borrow billions of dollars in the bond market, there is zero chance of Aussie interest rates going up.
That’s naturally bad news if you’re trying to save. In actual fact, it’s not such good news if you’ve got a mortgage either.
Even though it means your mortgage repayments will remain low, the high rate of inflation means your other living costs will still rise faster than your wages.
So over time you’ll find that you have less discretionary income.
This is why it remains important for investors to maximise income returns from investments.
We’ve highlighted the importance of tax effective investing in the Australian share market. It’s simple. You look for good quality companies that pay a fully franked dividend yield.
It’s basically a lucrative tax break that you can’t get with any other type of investment.
And the best news of all with franking credits is that unlike — for instance — a negatively geared property, franking credits don’t involve going into debt, and they increase your income rather than just decreasing your debt costs.
But looking for franking credits is only part of the story. In a continually low interest rate environment you also want to find opportunities where you can get dividend growth.
Many blue-chip stocks increase their dividends regularly. In recent years the major banks have been the best at doing that.
But it’s not just the banks that increase dividends. We’ve also paid a keen interest in the small-cap dividend payers. We like these plays because of the potential for rapid earnings growth, which should lead to rapid dividend growth too.
In the case of one small-cap ‘money’ stock we recommended in Australian Small-Cap Investigator two years ago, investors who bought in at the recommended buy price are sitting on a nice 6.2% fully franked dividend yield. That’s on top of the 75% gain inclusive of capital gains and dividends already paid.
And readers who bought into what we consider to be one of the safest property plays on the ASX three years ago, are now collecting a 7.7% unfranked dividend yield. That’s in addition to the 61% capital gain and dividends paid.
Investing in small-cap income stocks isn’t risk free. There’s always the chance that the company could cut the dividend. But in a low interest rate market where inflation-adjusted wages are falling, it’s important for investors to find new ways to boost their income.
Right now, if you’re after an income boost, and you’re prepared to take on the extra risk, there are few better places than the stock market to improve your cash flow.