Nobody can quite explain why stock markets have been climbing at a time when central banks are warning that interest rates could need to rise further. It is almost as though investors don’t believe that the cost of borrowing is heading higher.
Both the Federal Reserve and the European Central Bank have said that inflation is not under control, yet. Same goes for the Bank of England. So, further increases in the Fed fund rate, the European refinancing rate, and the Bank of England base rate are on the cards. But shares continue to rise.
Could it be possible that the market thinks that central bankers will be forced to bow to political pressures. We all know that the attention span of elected government officials extends only as far as the next polling day. Consequently, they are terrified by recession. They worry that they could lose votes if unemployment should rise.
As to whether central banks will continue to hike rates, as they have threatened, kind of hangs in the balance. If they do push up the cost of borrowing, then share prices could tumble. If they don’t then the buying power of the dollar in our pockets could shrink.
Somehow, we need a win-win strategy that could work in both situations. And that is where income investing could provide us with some help.
By focussing on the stable income that is generated by businesses, we can largely ignore the uncontrollable near-term movement in share prices. In the long run though, the share price of good companies should rise. In the short term, anything could happen.
However, dividends are far more predictable. And in some instances, the rate at which those dividends could grow can even be estimated with some accuracy. So, given what we know, namely, rising income generation, income investing could be a welcome panacea in these uncertain times.
And that is why Warren Buffett once said that he wouldn’t change a single thing he does, even if the Fed chair should tell him what the FOMC would do at its next meeting.
Point is, if a 100-basis point or even a half percentage rise in interest rates is going to break a business, then those are the kind of companies we want to avoid at all cost. We need to look for companies whose interest payments are well covered by cash flow.
We should look for businesses that are resilient in tough economic conditions. We should focus on shares that have a good track record of rising dividends. In other words, we want to invest in wonderful businesses selling at good prices.
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Disclosure: David Kuo does not own any of the shares mentioned.
