Mario Draghi, Chief of the European Central Bank announced this week that it will go to “Negative Interest Rates.” Negative interest rates go below zero. The new rate will be (minus) -.1%. What does all this mean?
Let’s imagine that you are living in Europe and have a bank account in a European bank. Your bank account has a substantial deposit of perhaps up one million Euros. Now you wake up to find that you are being charged .1% on your deposit to keep your money in the bank. Draghi says that the ECB is doing this to force you to lend your money instead of leaving it in the bank. Great theory. However, who would you lend it to? The growth of the European economy is barely above the flat line. Few want to borrow because they see little prospect of starting a new business and making a profit.
That leaves your large depositor with his money sitting in a bank and being charged to leave it there. What would you do to protect your money? Why, yes I’m going to pull it out of the bank and move it to a safe place. What would that place be? Why, yes, it’s the US dollar.
So, what could we expect in worldwide money flows? Most likely you will see money pouring into the US dollar, causing a rally from present levels. Now you have a new, and dangerous scenario unfolding. Now that European bank has less money to lend out, putting pressure on their bottom line. You could see bank defaults in some parts of Europe.
Moving now the United States, what do you do as an investor? You are seeing a dramatic shift in bank policy in Europe, with money coming into the US dollar. The US stock market has been making new highs several times this year. People are rushing to buy stocks, fearing that they are missing out in this bull market. The risk factor is at it highest level since the Tech Bubble with the lowest bearish sentiment and the highest bullish sentiment. If you remember when the bullish/bearish sentiment reached these levels in 2000, we saw the bubble burst.
The key question here is whether or not the big players will take their money off the table and stand aside for a while and let these events play themselves out. It is a time of extreme caution. You should take action to protect yourself in the event that the unexpected happens. We would see a market correction coming rather quickly.
Take the time to study your portfolio carefully. You may want to lighten up on some of your positions. To protect your profits, you must set stop loss orders under each stock. If you have a 401k do the same thing. Small investors were hurt badly during crash of 2008-09 because they didn’t know how to protect themselves. If the market does turn downward, you can buy “inverse” ETFs. These move up as the market drops. Do not let the crowd lull you into a false sense of security.