Executives and investors can fantasize all they want about fiscal stimulus or lower taxes in the aftermath of the U.S. presidential election, but they would be foolish to forget one fundamental truth: No matter what was promised on the campaign trail, interest rates in Canada and the United States will remain stuck at astonishingly low levels for years.
The harsh reality is the election winner is inheriting a ravaged U.S. economy that is still reeling from surging COVID-19 cases, which means economic growth will likely suffer for years. Amid this carnage, the central bank heads in both Canada and the United States have said they expect to hold rates next to zero per cent until 2023.
And yet, there remains hope for a magic bullet. This summer there were dreams of an early vaccine to protect against COVID-19. Lately there are expectations of a second stimulus package in the United States.
The truth is that there is no easy fix for the expected bout of anemic economic expansion. Even if the U.S. passes a second fiscal stimulus package, “all that is going to do is keep the growth rate positive,” said Dennis Mitchell, chief executive officer of Starlight Capital. “It’s not going to spike to 3 per cent.”
Because there is no quick fix, executives and investors are better off to bet on the same fundamentals that have persisted since the 2008 global financial crisis. Even though such a prolonged run of low rates once seemed unfathomable, it’s more likely that they’ll last beyond 2023 than it is they’ll rise sooner.
As Ian de Verteuil, a market strategist at Canadian Imperial Bank of Commerce, explained, the U.S. Federal Reserve already learned its lesson from raising rates too early in 2018. This time around, the Fed “is not doing anything until the economy is really on strong legs,” he said. “They’d rather wait."
If this plays out, the impact will touch every sector of the economy. Much of it will be troubling. For banks, it means they are not likely to see much lift in their net-interest margins – or the difference between the rates at which they borrow money and then lend it to clients.
But it also creates opportunities for new business models to flourish. In recent years, alternative investments such as real estate and infrastructure projects have become one of the hottest asset classes. Lately, though, there have been fears that these markets are overcrowded, with too much money chasing a small number of projects.
Yet with rates stuck so low, Canada’s Brookfield Asset Management is now building a business model around this sector – one it hopes to dominate as an early mover with scale.
“If real assets or alternatives have streams of income that are locked in, the valuation of those assets is going higher," CEO Bruce Flatt said at a September investor day. "So we believe, as we evolve out of this cycle and interest rates continue to stay low, that there will be significant increases in values of alternatives.”
Mr. Flatt added that Brookfield estimates alternatives will eventually make up 60 per cent of institutional portfolios, up from 5 per cent two decades ago.
Low interest rates also put equity valuations in a new light. For much of 2020 there has been disbelief that stocks could be worth so much in the face of soaring unemployment stemming from the COVID-19 crisis.
However, Mr. de Verteuil recently analyzed Canadian dividend stocks and found that the dividend yield on the S&P/TSX Composite Index now yields five to six times that of Government of Canada bonds.
He predicts this will create an opportunity in the near future for investors who are hungry for yield. In the thick of an economic crisis, economic indicators such as the unemployment rate take precedence to this disparity. But if COVID-19 becomes much more manageable next year, stocks won’t seem as troublesome, and central banks will still be in the same holding pattern for two years.
"This interestingly makes Canadian equities even more attractive from a relative perspective,” Mr. de Verteuil wrote in a report last week.
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