When Federal Reserve Chairman Ben Bernanke spoke to the National Association of Business Economists on March 26^th, 2012 he re-dedicated the Federal Reserve Bank to its current policy of easy money and low interest rates, noting in his prepared remarks:

“…further significant improvements in the unemployment rate will likely require a

more rapid expansion of production and demand from consumers and businesses,

a process that can be supported by continued accommodative policies.”

Like a shot of adrenalin to the markets, the Dow Jones Industrial Average on that Monday morning climbed some 160 points, leaving no doubt as to Wall Street’s love of low interest rates and cheap money.

The Fed has stated on numerous occasions since the advent of the Great Recession its justification for keeping rates unnaturally low. Low rates would stimulate business investment, bolster consumer spending, and underpin housing affordability as a means of stabilizing weak real estate markets. Cheap credit would also raise stock market valuations (as noted above), and the so-called “wealth effect” from higher stock prices would lead to further spending by investors. Not officially stated, but no less true, low rates on dollar-denominated assets would increase exports of U.S. goods by making the dollar cheaper relative to other world currencies. More cravenly, rock-bottom interest rates would allow the U.S. Government to finance its burgeoning spending The chart below depicts the magnitude of the challenge faced by policy-makers in dealing with $1 trillion plus annual budget deficits. Yet Federal Reserve policy has not been without costs and unintended consequences.

Michael and Nancy Hoagland, retired since 1997, would not have been pleased had they heard Chairman Bernanke’s continued pledge of low interest rates. Conservative in their investments, and “unwilling to sacrifice safety for yield”, the Hoaglands have had to curtail their lifestyle in an environment of scarce returns and low yields. The Fed’s zero interest rate policy had forced them to look at other means, typically involving more risk, to supplement low savings yields (“Difficult Choices”, Investment News, March 26, 2012). Nor are they alone.

Millions of retirees, savers and other holders of liquid financial assets are facing what has been variously referred to as “financial repression”, a term coined by Stanford University economists Ed Shaw and Ron McKinnon in 1973 to describe government policies aimed at suppressing interest rates below the rate of inflation for the benefit of the government and other borrowers, and notably at the expense of savers. The Federal Reserve, which has preferred to refer to their policy as “quantitative easing” and “accommodation”, has done this by means of a combination of holding short-term lending rates (the rate at which the Fed will lend to commercial banks) between 0% and 0.25%, coupled with massive purchases of government securities, mortgage securities and other financial assets, with the effect of lowering interest rates across the yield curve. The scale of this intervention is clear when looking at the vastly expanded size of the Federal Reserve’s balance sheet which grew from $888 billion in assets in the 3^rd quarter of 2008 to nearly $3 trillion by the 1^st quarter of 2012, and underpinning a dramatic $2 trillion increase in the money supply.

Financial repression as a policy, however, has been anything but an unalloyed success, particularly where savers are concerned. The chart below traces the level of personal interest income back to 1960.

While interest income typically declines in economic slowdowns and recessions, the magnitude of the decline in interest received by individuals in this period is unprecedented, having fallen from more than $1.4 trillion annually at the peak in 2008, approximately 11% of personal income, to less than $1 trillion currently. This is a decline of over $400 billion annually, or some 30% less interest income in the pockets of savers, while also losing the compounding effect of interest on interest. Take things one step further and factor in inflation, and savers and other holders of liquid financial assets are experiencing negative real yields. Given the importance of consumer spending to the health of the economy and growth, this dramatic decline in the wherewithal to spend has undoubtedly been a significant factor in the anemic pace of the recovery. Federal Reserve defenders will point to lower rates on mortgages and other lending as helping consumers and businesses. Yet even there the record is mixed. Households and businesses have been in a mood to de-lever their balance sheets and reduce their financial obligations, which has also had the effect of moderating economic growth.

Former Federal Reserve governor William Ford and researcher Polin Vlasenko add further perspective pointing out that low rates not only affect the usual savings vehicles such as savings accounts, CD’s, money-market funds and short-term term bond funds, but also life insurance policies, annuities and private pension funds. By their estimate, the upper bound of interest-sensitive funds approaches $18.8 trillion, no small change. Using a more conservative figure for the level of assets affected, they estimate that each percentage point reduction in yields reduces consumption by some $75 billion, a half percentage point of GDP activity, and 715,000 jobs lost. They further reckon that were yields at the average levels observed in the past nine recoveries, GDP would be 2.5 percentage points higher and there would be 3.5 million more jobs filled (The Downside of Monetary Easing, American Institute for Economic Research, July, 2011).

Those hoping that the interest received on their savings accounts and certificates of deposit will rise anytime soon are likely to be disappointed. Carmen Reinhart, who has written extensively on debt, and co-authored with Ken Rogoff “This Time is Different: Eight Centuries of Financial Folly”, believes that financial repression will be a fact of financial life for a considerable period of time as the Federal Government continues to run fiscal deficits and accumulate staggering levels of debt. With growth too anemic and financial austerity (higher taxes, lower spending) politically unpalatable, the Government will fall back on the more opaque strategies of “a steady dose of financial repression that is accompanied by an equally steady dose of inflation.” (Financial Repression Back to Stay: Carmen M. Reinhart, Bloomberg, March 11, 2012). And although there has been growing skepticism as to the efficacy of Federal Reserve policy, so long as it is the received wisdom that quantitative easing is “working”, savers will have few avenues for increasing their returns.

So what are savers and conservative investors to do in an environment of miniscule yields? Some will no doubt be tempted to take more risk with longer-term and/or lower quality investments, and may end up supporting the old adage that “more money has been lost reaching for yield than at the point of a gun”. The considerable flows of money into junk bond funds and funds that specialize in emerging economy debt would suggest many savers are doing exactly that. In reality, however, keeping quality high and interest rate risk low is likely the most prudent approach if capital is to be preserved and positioned to capitalize on better opportunities in the future. And while equities are never to be confused with savings or even bonds, there is a place in portfolios for the shares of companies with durable revenues, strong cash flows, high returns on invested capital, and managements that respect shareholders’ capital. The period ahead promises to be an interesting and potentially quite volatile one as we reach an inflection point where there is either more evidence that current policy is working, or just making things worse.

Performance figures shown are past performance and are not a guarantee of future results. Due to market volatility, fund performance may fluctuate substantially over the short-term and current performance may differ from that shown. The value of the Fund’s shares and their return will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Performance data current to the most recent month end may be obtained by calling 800-551-3998. Periods over one year are annualized.

Investors should consider the investment objectives, risks, charges and expenses of the fund carefully before investing.  The prospectus contains this and other important information about the Fund and may be obtained by calling 800-551-3998.  Read it carefully before you invest.

The Becker Value Funds are distributed by Unified Financial Securities, Inc., 2960 North Meridian Street, Suite 300, Indianapolis, IN 46208. (Member FINRA). Copyright ©2012, Becker Capital Management, Inc. All rights reserved. Russell 1000 Value Measures the performance of those Russell 1000 companies with lower price-to-book ratios and lower forecasted growth values. The performance of the index does not reflect deductions for fees, expenses or taxes. Index is not available for purchase.  The S&P 500 is an unmanaged index which includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Index is not available for purchase. © 2012 Morningstar, Inc. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providersare responsible for any damages or losses arising from any use of this information. Past performance is no guarantee of future results. For each fund with at least a three-year history, Morningstar calculates a Morningstar RatingTM based on a Morningstar Risk-Adjusted Return measure that accounts for variation in a fund’s monthly performance (including the effects of sales charges, loads, and redemption fees), placing more emphasis on downward variations and rewarding consistent performance. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. (Each share class is counted as a fraction of one fund within this scale and rated separately, which may cause slight variations in the distribution percentages.) The Overall Morningstar RatingTM for a fund is derived from a weighted average of the performance figures associated with its 3-, 5-, and 10-year (if applicable) Morningstar Rating metrics. The Fund had the following rating for the 3-year period ★★★ out of 1,098 Large Cap Value Funds and ★★★★ for the 5-year period out of 973 Large Cap Value Funds. Based on the fund’s inception date there is no 10-year rating.

Perspectives

First Quarter 2012 Newsletter