Low interest rates help to decrease the cost of capital. In layman’s terms this means that companies are able to finance operations with fewer funds and increase profits.
Pension funds have a hurdle rate, a minimum rate of return. When the U.S. government sticks short term interest rates near zero, investors are forced into stocks and other risky investments to achieve their minimum rate of return. This increased demand helps to boost stock prices.
Is it Dangerous to Bet on Rising Asset Prices?
As long as interest rates continue to fall, betting on rising asset prices is any easy way to make money. The downside is that as soon as prices stop rising speculators stop buying, and then prices collapse. A look at the billions of dollars lost in the wake of the tech bubble should be a clear warning sign. The chart below shows how even in the midst of bubbles, lowering interest rates have helped to boost the stock market.
What is an Investor to Do?
Buying a slice of the broad market has its downsides. It is like going to the grocery store and buying a bag of apples. Later you come home to find out that half of those apples were rotten. Selecting companies with defendable moats is a safer way to invest.
Exxon Mobil Corporation (NYSE:XOM) has maintained their dominant position in the energy sector for decades. Energy is known for being highly temperamental. Price swings and overly optimistic projects can bankrupt companies and leave CEOs blindsided.
Exxon Mobil Corporation (NYSE:XOM) takes stability seriously. Through the integration of production and refining assets it has built in safeguard against volatile price swings. If a sudden fall in the price of oil causes losses in their upstream operations then their downstream facilities can help to maintain profitability.
The company has only $7.9 billion in long term debt. The lack of debt shows that the management is able to drive earnings and profits without relying on cheap loans. In 2012 the firm posted a return on average capital employed of 25.4%, a rate significantly higher than that of their competitors. This company offers a stable business and trades at a very attractive price to earnings ratio of 9.1.