If 2020 was a Math Problem

If you’re going down a river at 2mph and your canoe lost a wheel, how much pancake mix would you need to force the market back to an all-time high?

Sometimes investing seems this complicated, but it doesn’t need to be when the correct answer is: Don’t Fight the Fed. 

The Federal Reserve (“Fed“) is the central bank of the United States. The Fed performs a variety of functions with the mandate to promote stable prices and maximum employment. One of the tools that the Fed uses to accomplish this is by influencing interest rates. 

Essentially, interest rates are the lifeblood of the economy. When the economy is running too strong the Fed will put on the brakes by increasing rates. Higher rates result in less borrowing and a reduction in spending. The opposite holds true when interest rates fall. When the Fed is concerned that the economy is slowing down, they will lower rates to promote borrowing and stimulate economic activity. Since February, the Fed has cut rates from 1.75% to 0.25% - the Bank of Canada has followed suit.

In times like these, you’re lucky to collect any interest from a chequing account and the oxymoron account (high interest savings account) might fetch you 0.25% per year. Having money on the sidelines is great for emergency purposes, but keep in mind a hidden tax (inflation) is nibbling away at your purchasing power. Every year that passes your idle cash becomes worth less and less. Not on paper, but based on the amount of stuff that you can buy with it.

Circling back to the relationship between interest rates and asset prices – when depositors are not being compensated on their day to day accounts, they are inclined to become investors and reach for more returns by way of taking on added investment risk. In other words, when interest rates are at or close to zero percent, investments such as bonds, stocks or real estate look much more attractive as an alternative to cash.