Source – Forbes.com
Can it be happening again? Just a few years after badly missing the subprime bubble, is the Federal Reserve setting us up for another doozy of a crisis? By slashing short-term rates to historic lows six years ago and promising to keep them low for quite some time, the Fed appears to be ignorant of the futility of such a policy to spur economic growth and of the significant inflationary risks that it carries.
Easing rates during the financial panic in 2008 was the right move in stopping the economy from plunging over a cliff. By late 2010, however, the recovery was already under way and the unemployment rate was falling, but the Fed kept the federal funds rate just above zero.
Drastic bending of monetary rules has produced the slowest economic recovery since World War II. When investors or businesses are frightened, it does not matter how far interest rates fall. They will still have a limited effect on increasing capital spending and employment.
The Fed sent mountains of cash to banks to rebuild reserves decimated by the subprime mortgage meltdown and domino effect on the economy, but this was no economic tonic. Banks had no appetite for risk and drastically cut lending to smaller companies, curtailing their expansion and forcing them to lay off workers.
Another problem with freakishly low rates for tens of millions of investors in Treasury or high-quality corporate bonds–or anybody who saves via traditional savings accounts–is that they earn virtually no real return when you factor in inflation. An extended period of low rates would be devastating to such investors in the future.
So what is the best course to take? You could own a diversified portfolio of value stocks that should perform well even in a slow-growth economy while also providing above-average yields. Another good investment is to own your home. If I’m right, Fed policies will inevitably produce much higher inflation. In this environment, value stocks and real estate should both protect or even grow capital in real terms.
Venturesome types should consider conservative U.S. banks, which are only now emerging from the crisis. Subprime nightmares are only a memory, and beefed-up reserves provide good protection from the likes of another serious crisis in the future. Look for steady increases in earnings and dividends in the years ahead. There are several ways I’d play banks.
The SPDR S&P Bank (KBE, 32) is an ETF that equally weights 57 bank stocks, including national behemoths like JPMorgan Chase and Bank of America , as well as regional names like Zions Bancorporation. The diversified portfolio is split fairly evenly among large-, mid-, and small-cap banks and yields 1.4%.
BANK OF NOVA SCOTIA is Canada’s third-largest bank. Stricter lending requirements for mortgages helped keep the banks out of trouble during the subprime crisis. Many even benefited by picking up strategic assets in other countries at fire-sale prices. Bank of Nova Scotia is a solid Canadian bank, with a P/E of 12 and 3.4% dividend yield. Dividends have grown almost every year for the past two decades.
PNC Financial Services Group has benefited from stronger commercial loan demand in the U.S. PNC’s ability to generate cash and build a stronger balance sheet support sustained increases in both earnings and dividends over time. Its dividend is up fivefold since 2010. PNC yields 2.2% and trades cheaply at 11 times earnings.
Wells Fargo is one of the largest bank holding companies, with 9,000 branches and offices in 35 countries. It makes most of its money from old-fashioned banking activities and largely eschews fancy trading techniques that have felled competitors. Dividends are up 600% in the past four years with further increases likely ahead. Wells looks good with a modest P/E of 12 and a 2.4% dividend yield