How To be Smarter And Richer

The chair of the US Federal Reserve, Janet Yellen, could not have been clearer, if she had sent a squadron of skywriters to spray her message in giant letters onto the skies of Washington, D.C.

So, forget about trying to decipher cryptic messages from the Federal Reserve. Forget, also, about trying to read between the lines, when reserve bank presidents speak.

US interest rates will be going up before the end of this year, whether we are ready or not.

Most, most, most.

The actions by the Federal Reserve could have implications for many economies around the globe. That is because the US dollar is the world’s reserve currency.

It is the currency that is used most in international transactions. It is the currency that most commodities are priced in. It is also the currency that governments around the world hold the most of, as part of their foreign reserves.

So what the US decides to do with interest rates could impact all of us.

Curiously, the US doesn’t actually need to raise the cost of borrowing, if we believe that the purpose for doing so is to control inflation. The recent monthly inflation numbers from the US Bureau of Labor Statistics speaks volumes.

Dip, dip, dip

In January consumer prices fell 0.1%, while in February prices were unchanged. In March prices dipped 0.1% again. In April, the price of the judiciously-chosen basket of goods, which is supposed to reflect the things that US consumers buy, fell 0.2%.

So from an inflationary perspective, American consumers are not spending their money frivolously.

In terms of the US economy, though, arguments can be made both for and against a rise in interest rates.

As far as the positives go, America is growing at an annualised rate of about 3%. The unemployment rate has halved from around 10% over the last five years too.

But there are negatives.

While the number of people out of work has fallen, wage growth has been notably sluggish. The quality of jobs created has hardly been impressive either, with more people working part-time.

Why, why, why?

So why, then, is Janet Yellen pressing for a rate rise?

The answer lies in asset prices. The flood of money that central banks have created has failed to stimulate consumers into spending more to drive economic growth. But it has boosted asset prices.

Specifically, it has pushed up bond prices to abnormal levels, which in turn has depressed bond yields to unusually low levels. Yellen wants to restore some sense of normality to those markets.

Currently, bond yields are below dividend yields. That is abnormal.

Admittedly, there was a time when investors demand that dividend yields were substantially higher than bond yields. They reckoned they deserved more because they were taking on more risk by buying shares.

All change

But things changed about 60 years ago. Smarter investors realised that dividends could grow over time and eventually overtake the fixed income from government bonds.

We need to think smarter, too.

Since 2004, SingTel (SGX: Z74) has increased its full-year dividends from S$0.06 to S$0.17 per share. Over the same period, the payout at Jardine Matheson (SGX: J36) has risen from S$0.65 to S$1.92. Meanwhile, Keppel Corporation (SGX: BN4) has grown its distribution at a compound rate of 18% a year.

That is why we should prefer stocks over bonds. Or as Peter Lynch once quipped: “Gentlemen who prefer bonds don’t know what they are missing”.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.