Penny Stocks and Low Interest Rates
by Ed Zwirn
Read all the past Blog entries here
Federal Reserve Chairman Ben Bernanke, in his testimony before Congress today, gave an unsurprising recap of the effects of both government spending and central bank monetary policy on the U.S. economy. As we have already pointed out, the market for everything from penny stocks to blue chips should continue to benefit as long as the Fed maintains its accommodative policy of pumping money into the economy, and Bernanke's reiteration today of the Fed's intention to increase this stimulation if necessary should prove to be a tide that helps to lift all boats.
The Fed's traditional method of pumping up a lagging economy has long been the manipulation of the Federal Funds rate and other key target interest rates. By printing money to manipulate financial markets and keep these rates low, the Fed has ensured that a continued expansion of the money supply, even as the government reduces spending, is available to chase investments in penny stocks and elsewhere in financial markets.
But in today's testimony, Bernanke pointed out that the Fed's engineering of low interest rates could pose risks to the economy, risks that at the same time involve opportunities for penny stocks.
"A long period of low interest rates has costs and risks," he said, noting that as savers who rely on interest income chafe under continued low yields, "very low interest rates, if maintained too long could undermine financial stability."
"Investors or portfolio managers dissatisfied with low returns may 'reach for yield' by taking on more credit risk, duration risk, or leverage," he told members of Congress.
Of course, this is no comfort for those of us concerned about the prospects for financial instability in general and a possible repeat of the market meltdown we saw several years ago. But the penny stock investor should be aware at the same time of the potential benefit to be reaped by low interest rates for penny stocks and other investment vehicles and the more risky end of the risk/reward spectrum.
I didn't always work on penny stocks. I personally witnessed the effect of yield hungry investors in the years leading up to the last financial market meltdown, when I had a day job providing market insight and analysis of junk bonds, debt instruments for which the likelihood of default is considered higher than those issued by larger, more established companies with better balance sheets.
Now this yield-seeking scenario is apparently playing itself out again, as hungry investors look to penny stocks and other investments to secure better returns. Whatever this may tell us about the genuine long-term risks posed by low interest rates to the economy, this hunger for yield can only help boost your penny stock portfolio in the meantime.
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