The Federal Reserve has warned that rising asset prices are posing increasing threats to the financial system. It pointed out that they could be vulnerable to significant declines if risk appetite should fall.
It said that even though the overall financial system has remained stable through the COVID-19 pandemic, future dangers are rising if the aggressive interest in stocks tails off.
As a remedy, one Fed Governor has suggested that banks should be required to increase their capital requirements during expansion as a buffer against downturns.
The governor’s suggestion borders on being almost cringeworthy. Banks are not to blame for rising asset prices.
It is akin to a parent who leaves out a box of chocolates and then wonders why a toddler has fallen ill after munching through the selection of confectionery. Who should we blame, the parent or the child?
The Fed has created this unfortunate situation because it has cut interest rates to historic lows, printed an unprecedented amount to money, and pushed Treasury yields lower by buying up billions of dollars of US debt.
What on earth were rational investors supposed to do?
It stands to reason that asset prices would rise as investors pile into shares, property, and bonds to capture any sort of yield they could lay their hands on. It is little wonder that stock markets have climbed to all-time highs.
It also stands to reason that the higher that share prices rise, the more they could fall if and when investors fall out of love with the stock market. But here is something that investors – especially we, income investors, – should think about…
…. the price of a share is the product of two separate ratios. The first is a function of market sentiment. The second is a function amount of profit that a company can generate.
We can’t do anything about the first. So, focus instead on the things that we can control, rather than the things we can’t.
Focus on companies with sustainable earnings and reasonable payout ratios. That could go a long way for us to enjoy dependable dividends from our portfolios.
But don’t worry too much about share-price volatility….
…. What the market gives in terms of share-price appreciation, the market can always take away. But what a company pays in dividends is ours to keep forever.
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David does not own shares in any of the companies mentioned.
