Sated by pronounced monthly gains in stock market indexes during August, American investors and others worldwide whom regulators should try to protect, instead stand vulnerable now to life-changing downward adjustments in the value of their financial holdings.
Just as shadowy non-state terrorist groups make existential threats against Israel, the U.S. and western civilization, powerful and once-friendly nations simultaneously challenge the dominant role of the American dollar in global finance and the military presence of our fighting forces in strategic choke points.
Experiments in regime change directed by the Obama administration lit tinderboxes many places starting in 2009 — now this protracted interference abroad and loose control over our southern border could ignite conflagration among nuclear powers.
In September 2014, President Obama doesn’t have the financial resources, the good will, or the temperament to vanquish enemies while also retaining the enormously valuable right to manage the U.S. dollar as the world’s reserve currency for much longer.
Rising interest threat
Interest rates on U.S. dollar-denominated federal government securities have fallen for so long that most market participants have little personal memory of what happens to asset values when benchmark interest rates rise.
In large nations such as the U.S., where citizens earn incomes that are high on the world scale and where investors have accumulated substantial wealth, protracted declines in key interest rates spur economic activity and propel most asset values upwards.
Conversely, when interest rates rise and, worse, when households, businesses, financial institutions and governments inside the U.S. are required unexpectedly to reduce their aggregate borrowings, most asset values plummet.
How high could interest rates on 10-year Treasury notes rise? In August 2008, as the worst recent chapter in the global financial crisis opened, the average interest rate on those notes was 3.89 percent — a level 1.6 times their August 2014 average rate of 2.41 percent.
A further seven years earlier — during August 2001 — 10-year U.S. Treasuries yielded 4.96 percent, or slightly more than twice what they do now. Further back still, in August 1990 as the U.S. started to reckon with Saddam Hussein’s invasion into Kuwait and the waning days of the Soviet Union, the average yield was 8.75 percent.
As investors watch escalating international tensions, their growing realization that the Federal Reserve System and our government may soon lose latitude to keep America’s total debt balances high and U.S. dollar interest rates low could exacerbate the looming stock market rout.
Three quick examples
Experienced investors view with alarm long periods when dividend yields on common shares near or even exceed interest rates on benchmark government bonds. As of last Friday, the dividend yields on IBM common shares were nearly equal to the yield on 10-year U.S. Treasuries, and the ratios rose to 1.1 times Treasury yield for Wal-Mart common shares, and 1.5 times in the case of GE.
Investors in IBM who crave annual yield may miscalibrate downside risks in the gathering global crisis. Intertwined in global markets, IBM has lost ground inside the U.S.: American revenues in 2013 declined 5 percent from the full-year results in 2007, the last pre-crisis year, while pre-tax profits declined 11 percent.
Less exposed internationally than IBM, Wal-Mart generated only 2.1 cents in free cash flow for each dollar of revenues in its last full year of operations, a razor-thin cash-flow margin that offers scant protection in a rising interest rate scenario.
Still carrying massive debt, GE saw its U.S. revenues shrink 20 percent from 2007 to 2013, while pre-tax profits in the U.S. fell 32 percent. An obvious target in spreading global conflict for many reasons, GE seems most exposed of these three widely-held corporate names.
In coming months of roiling tension, fortune will not favor myopic greed.
• Charles Ortel serves as managing director of Newport Value Partners (NewportValue.com), which provides economic research to executives and to investment firms.
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