Fed governors are telling us the natural pace of long-term economic growth in America is in the 2% range, possibly lower as time goes on. Therefore, a neutral interest rate is likely lower than the market currently expects.
In short, America’s interest-rate destination is much lower than most commentators suspect. It’s certainly nowhere near traditional neutral rates in the 5% range.
If the economy is growing at its long-term expected rate of roughly 2%, then we can back into the Fed’s likely interest-rate destination by using something called the Taylor Rule. It was developed back in the 1990s by famed economist John Taylor, and various studies have shown that the rule is pretty good at plotting the path of central bankers around the world. Plugging in the Fed’s GDP expectations and various factors for expected inflation, I come up with a terminal Fed Funds rate ranging between about 2.25% and,maybe, 3.25%.
Think about what that means for your life…
Sure, interest rates will remain subdued for housing and consumer credit. But if your goal is to earn a greater return on your assets … well, it’s not going to be found with traditional fixed-income instruments. We will not see a 5% CD until well into the 2020s, unless inflation explodes higher — and if it does, then we will be stuck in a very stagnant 1970s-style stagflationary environment that will make today look like Bill Clinton’s roaring ‘90s.
The only solution we have: high-quality dividend stocks.
Though you don’t hear this a lot, dividends are the key reason the S&P 500 has been such a good investment long term. A $1,000 investment in the 1970s turned into $20,873 in terms of stock-price appreciation alone through the end of September. Dividends added another $63,037 — triple the price appreciation.
We are in a long (looong) term period of subpar growth in America. The Fed’s own expectations tell us as much. Dividends will prove to be our savior over the next decade.
This article is brought to you courtesy of Jeff D. Opdyke.