Interest rate cuts: Does it provide long-term benefits?

When rate cuts happen, people think that the economy is weak so that it required a rate cut. The reduced rate provides stimulus to the economy which resulted in the stronger GDP, higher corporate profits and higher stock prices. This is the first-level thinking.

Rather second-level thinker thinks that –

  • Why do rate cuts happen?
  • The economy is weak or weakening?
  • What damage can occur if rate cuts not happen?
  • How much worse it is?
  • Does this rate cut help to revive things?
  • Shouldn’t we need to take rate cut as a worrisome scenario?

A very nice example quoted by Mr. Marks that when we visit a doctor for our weak health and then he works on healing us through higher treatment, should not this worrisome for us?

First level thinker takes it as this treatment heal us and we will get all right soon

Whereas second-level thinker take it as –

  • how much worse it is that such high treatment is required? Or the situation is worsening highly?
  • Does it resolve the issue?
  • Is this treatment sufficient?

We need to think that the doctor has to bring a higher treatment that means simple treatment does not go to work for healing us. This means either issue is big enough or it is on the way to becoming bigger. So that when we have a bypass that means chest pain is not because of a gas problem but actually, we have a heart attack.

What can lead to growth at a lower interest rate?

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  • Lower cost of borrowing – lower interest on EMI – more savings leads to more spending on the consumer front and that resulted in the GDP growth
  • Lower cost of borrowing – encourage businesses to make an investment – lower cost leads to more cash left with businesses to make further Capex – earning starts growing – more dividends or stock buyback enhance cash inflow to the investors – more spending – that increases GDP
  • Consumer spending increases – demand increases – encourage businesses to invest – more employment opportunities – more wages – increase consumers spending – GDP increases

The most important thing is that when interest rates go down then we reduce discount rates also. So that lower discount rates resulted in the higher assets prices. And lower rates encourage investors to take more risk to earn more return in the low return world.

Rate cuts provide hints for future rate cuts. And the above cycle keeps repeating.

There are many situations where lower rates are undesirable –

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Low rates increase the inflation (some inflation is required for the growth but excessive can kill) – too much inflation increases cost of living – it makes hard for people to spend more money – lower rates reduces the return on the cash, money market investments, high-grade bonds so that people make an investment into the risky products to earn more return – people take more leverage to make an investment – this creates an assets bubble & some point of time it will burst.

Due to the lower interest rates, we provide lower discount rates to the assets which have increased the price of the assets and when the bubble burst interest rate increases which creates huge damage to the prices of the assets.

This is like painkillers which cure pain for now but harmful to health over a longer period if we continue with taking painkillers frequently for immediate relief then it can destroy our health in the future. So, we need to be careful while taking a painkiller for curing pain at the time.

We need to focus that whether growth is natural or artificial stimulating growth. If growth is not natural then central bank and government have to take measures to boost growth. Such kind of growth does not survive for long without stimulation.

As current slowdown is not only cured through rate cuts but the government need to bring further measures which can provide long-term domestic growth without any temporary stimulation. Temporary stimulation brings future demand in the current period or till the stimulation remains in the force. After that demand starts getting dry up. Such a stimulus can be more harmful and lead to huge damage to the economy at whole.

Inspired from Howard Marks memo – “On the other hand”

 

WARREN BUFFETT’S LETTER – 2015 – 2017

Warren Buffett’s Letter 2015

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Similarly, India has a GDP growth rate of 7.20% and population growth of 1.10% which increase to the per capita growth by 6.10%. if we consider average per capita growth rate of around 5% for coming 20 years then it will reach the gain of 100%+. So that per capita will increase to $3927+ from $1963.55 currently, which will enhance the standard of living of our future generation.

Warren Buffett’s Letter 2016

Mr. Buffett has explained mistakes of acquiring businesses –

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Mr. Buffett on assets funding through debt-

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Mr. Buffett on fear –

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When we are fearful with our investment decisions then we focus on the each and every aspects which can result in the erosion of the capital. When I make an investment, I assume that from the next day of my investment; 1929 great depression will hit so whether I survive or not? Survival should be much more important to build a wealth which is not focused if we do not remain fearful with our investment.

Mr. Buffett on the repurchase of shares –

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Many companies are coming up with the repurchase of shares, we should consider that whether repurchase did at a discount to the intrinsic value or at a premium. If a company is paying a premium to repurchase shares then it will not benefits much to the shareholders. If any company make a decision to repurchase shares at a discount to the intrinsic value then we should look for the company. Many companies which are into commodity business or into the cyclical nature of the business also make a repurchase share during the worst time.

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Examples of Buyback at discount to intrinsic value, cyclical companies buyback, companies which have done a buyback rather repay debt SIMPLE IS BETTER – ISSUE -13 – BUYBACK

Warren Buffett’s Letter 2017

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If our investment does not provide us with protection against the inflation then we should not stay for a long term with a particular investment. Our first motive for making an investment should be protected against inflation and then create wealth for the long-term horizon.

Warren Buffett’s Letters

WARREN BUFFETT’S LETTER – 2011 – 2012

Warren Buffett’s Letter 2011

Mr.Warren Buffett has explained on the commodity to brand-

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One of the plastic product manufacturing company which use crude oil & it’s derivatives as a raw material but due to selling a brand company can increase a profit higher than growth to the sales

Supreme Ind

One of the footwear manufacturing company which use rubber, plastic I.e. crude oil derivatives as a raw material but due to selling a brand company can increase a profit higher than growth to the sales

Relaxo

Mr.Buffett on investing-

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When we make a compromise with our need and make an investment of those savings to the proper assets, we can able to receive more purchasing power in the future. We need to majorly focus on the beating inflation for the longer period of time which will provide us a more purchasing power in the future. Our minimum target to earn a return from our investment should be inflation rate + GDP growth rate. This is an appropriate return which will provide us a more purchasing power in future and also build us wealthier. During the current scenario in India, inflation rate 3.77% + GDP growth rate 8.20% = 11.97%, it should be a minimum threshold return from the investment we make.

If we look at the 10 years average inflation rate and GDP growth rate in India then it is 7.71% and 7.17% respectively. So that if we have made an investment in the year 2007-2008 than we should have minimum threshold return of 14.88%. and for the last 20 years is 14.60%.

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Warren Buffett’s Letter 2012

Mr.Buffett on intrinsic value creation –

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Mr.Buffett on capital-intensive business –

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We can use a similar parameter for analyzing a capital-intensive business. Here, we can check that whether the company has higher interest coverage after paying current year interest cost or not. This parameter indicates that the company can pay comfortably interest cost on additional borrowing or not. Such quality will not easily available with all the capital-intensive companies so that we can able to filter out good company from the capital-intensive business segment.

One of the FMCG Company which is the manufacturing and marketing of household products and personal care products

Godrej Consumer

One of the laboratory business company of India

Thyrocare Tech

Warren Buffett’s Letters 1957 – 2012