Dividends4Life: Interest Rates: Things Are Not Always As They Have Been

Each month the Wealth, Money & Life Network chooses a topic as that month's theme. Since our members are a diverse group, the selected topic is usually broad, allowing each of us an opportunity to address it from our perspective. This month, Interest Rates was selected as our topic.

Historically, stock investors cheered when the Fed lowered interest rates. This nearly always would lead to a run up in the stock market. Lately, the Fed has been firing blanks.

First, some background. Fed above refers to the U.S. Federal Reserve Bank and the interest rate is the federal funds rate. This rate is what the Federal Reserve banks charge member banks to borrow money. In the past, the Fed would use this rate to attempt to control inflation and direct the economy. When the economy was heating up and inflation was a threat, the Fed would raise rates to slow the flow of money to businesses, which would in-turn slow the economy and hopefully head off inflation. Conversely, when the economy slowed too much and inflation was no longer a threat, the Fed would lower rates to increase the money supply and stimulate the economy.

So after several rate cuts, why isn't the U.S. economy responding? Things are not always as they have been. There are many factors driving the current state of the U.S. economy, but I will focus on the two I consider the most influential.

I. Energy Costs
Even with a slowing economy the U.S. is experiencing a degree of inflation. This is driven by the pass-through effect of energy costs. As the price of diesel fuel goes up, so does the cost of transporting food, electronics, equipment, industrial goods and everything else that is sold in a place different than where it was manufactured. These costs are ultimately passed to consumer. While this has been bad for many business and the economy, some companies have benefited enormously. Consider my recent stock analysis of Exxon Mobil Corp. (XOM). Their enormous profits have pushed the company to a point I consider it grossly overvalued. The same could be said for Chevron Corp. (CVX).

II. Financial Markets
Instability in the financial markets has contributed to the current economic condition. Even though money is relatively cheap, there is not a rush to lend or borrow. The sub-prime collapse has caused fear and unrest. Even with low interest rates, banks are hesitant to loan money given recent, and very public, write-downs they have had to take. As a former shareholder of Citi Group Inc. (C), I watched as C went through a financial melt-down, took out a payday loan before slashing their dividend. Now the spotlight is on Bank of America (BAC). Will it follow the same path as C?

From a consumer's standpoint, each of the above has caused a great deal of concern. When people are concerned about losing their job, they aren't as apt to spend, further dragging the economy down. With all this fear and uncertainty, it is a great time to be a dividend investor!


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8 comments

  1. passivefamilyincome // July 9, 2008 at 6:53 AM

    Great post. I agree with both of your points on why the economy is not responding.

  2. lulugal11 // July 9, 2008 at 10:18 AM

    Excellent points. It makes you wonder why the man on the street sees certain things that the Fed is doing wrong but the Fed does not seem to get it.

  3. Jae Jun // July 9, 2008 at 11:20 AM

    Good points D4L.

    I also believe it's due to the excess money the Fed printed out back in 2003(? I think) thus increasing the money supply, which in turn isn't exactly helping to strengthen the dollar.

  4. Anonymous // July 10, 2008 at 4:26 AM

    questyion i read through the div net and nobody talks about PM, phillip morris international, it is my largest stock holding and I honestly see it doing double digit growth for the rest of my life. It was the best performing part of altria which was the best performing stock of the past 50 years at well over 100,000% n that time frame. It also pays a nice div at 3.5%. Just curious why none of you div guys like it. Is it because its ethical thing?

  5. Dividends4Life // July 10, 2008 at 5:54 AM

    Anon: I can't speak for the others, but for me I don't invest in "sin" stocks. Each of the products represented has had a detrimental effect on someone in my extended family. For me, it is not something I am comfortable investing in.

    Best Wishes,
    D4L

  6. Tom // July 11, 2008 at 5:22 PM

    After reading your post, I did a little research on the energy sector and it's insane what some of those companies are trading at.

    BTW, great points and I love the blog!

  7. Anonymous // July 12, 2008 at 9:36 AM

    Great blog, brother. Keep on trucking.
    Long live Jeremy Siegel and dividend investing.

  8. TheLocoMono // July 13, 2008 at 3:38 PM

    Having taken notice of the interest rates in the past five years or so, I never realized how much of an influence interest rates can have on the economy.

    It is a good to learn what causes and effects lowering/raising rates can have,not just for savers but for spenders and the economy as a whole.

    I can see why dividends are more attractive for the longer term because interest rates are truly short term and simply put, beyond the control of investors.

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