Markets set rates

We all know one thing about most investments. They go up and they go down. When you put money at risk, we all pretty much understand that we may lose some or all of it. The theory is that the less risk that you take, the less likely it is that you’ll suffer a total loss. On the other hand, the more risk that we take, we would hope, not anticipate, expect or guarantee, a greater rate of return than your conservative alternative.

The best example of this in recent memory is your bank deposits. In exchange for an extremely low risk of loss, you accepted a very low rate of return in the form of interest. The one benefit of rising rates is that savers who have been penalized by low interest rates are beginning to see the interest income on their bank deposits rise.

But is this always the case? Some may consider this rhetorical, but recent history begs the question in terms of global interest rates at this moment. Consider this. Italy has recently been in the news about their fiscal condition. Some consider economic conditions in Italy as bad as they were in the U.S. just around the last banking crisis. But today, if you wanted to lend money to our government for 10 years, you would earn approximately 2.84 percent per year (as of May 30). Yet if that same lender were to decide to instead lend money to Italy for 10 years, that investor would earn approximately 2.92 percent per year. Not as big a premium as one may expect if you believe the USA’s credit rating is or should be superior.

The point is that markets set rates, not governments.

The same is true for riskier assets. Companies don’t decide what they want their company to trade at, the market decides. For every buyer, there is a seller. And we would expect that both parties are satisfied. The seller was happy to sell and the buyer was willing to invest at that price. Real estate can be seen in a similar light. You may list a property at $X, but its fair market value is what a willing buyer pays you to move.

Market supply and demand pricing is deemed fair because everyone had an equal shot to bid on the asset or investment. This may not be true in certain situations where supply and demand are out of whack. There will always be times where there are more sellers than buyers and vice versa. These situations will cause fluctuations in market prices, either up or down.

The question, that may be rhetorical, is how long do market cycles last? No one really knows. When the 10-year Treasury rate was nearly 15 percent in 1982, did you believe that rates were headed down until January 2015, when they reached 1.88 percent? That is a 33+ year market cycle.