Record Low Interest Rates Fight Persisting Fears

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The frantic screamers of the financial media almost ignored two significant business milestones. China passed Japan as the second largest economy in the world and General Motors filed for its new public stock sale. News of house price declines and sour reports on continuing unemployment probably make for more grabby sound bites. Such bulletins may have more impact on stock prices over the next few weeks but the other two events will have more influence over the next few months.

China still ranks number 145 in per capita Gross National Product. It faces interesting challenges from India (#175) as both gear up to serve world markets. Japan (#11) seems stuck in deflation but its growth rate of exports bottomed out last year and its economy is growing with the chances of a “double-dip” recession negligible.

The same is true in the US (#6). The housing industry that powered much of the growth of the prior decade is suffering lower prices with every report. Based on past cycles, prices will not bottom out for at least another year, perhaps two. Construction is labor intensive and this slump is adding 1-2% to the unemployment rate. It also takes a chunk out of the balance sheets of homeowners with resulting damage to their spending (and borrowing) spirits.

The most recent home sales report was the lowest in the 15-year history of this economic indicator. As the forthcoming General Motors IPO suggests, government spending to stimulate vital sectors of the economy can be beneficial to all parties. The housing industry could use another round of federal stimulus through tax credits or other means. With our legislators locked into wrestling grips with each other, any relief here will have to wait until after the elections.

Stimulus through low interest rates is not waiting for any elections and the Federal Reserve may be relied upon to keep rates at their current record lows for another year or two. Investors are aiding these endeavors by deserting stocks for the apparent relative safety of bonds.

The results are amazingly low yields with money market funds offering around a tenth of a percent. IBM (IBM-$125-2.1% yield) just issued a three-year note paying a whopping one percent. The government is paying only 3.56% for 30-year bonds and Norfolk Southern (NSC-$53-2.7% yield) just sold a 100-year bond with a 5.95% coupon.

I recommend the stocks (but not these bonds) of both companies for their decent dividend yields and reasonable expectations of dividend increases as well as for gains in their stock prices whenever the market recovers its breath. Both have increased their dividends for eight or more straight years, a period that spans the recent financial panic.

Although understandable, the emotions that produced the panic are still so prevalent that the current bargain valuations on blue chip stocks may become even bigger bargains as stockowners sell stocks in order to buy the apparent security of bonds, gold or whatever may be in fashion.

DuPont (DD-$40), for example, currently pays a $1.64 dividend for a 4.1% annual yield. It might slide a bit pending market stability but in two years, it will have paid $3.28 (more with a dividend increase) and will have almost certainly increased its annual earnings to well over $3.00 a share. Investors need to look beyond the current surface chop to the horizon.

Investors can ease the waiting with bonds that the fearful overlook. Western Asset Global Corporate (GDO-$19), my newest pick, yields 8.3% paid monthly. It is a closed-end bond fund formed last year and currently trades at a 5% discount from net asset value. Its yield easily outweighs any risks.