Rising Prices and Budget Cuts: 3 Things to Do With Your Money Now
- April 17, 2011
- 8 comments
- Posted in Government, Investing, Latest Posts
Stay with your stocks, is the message that investors are getting from some key market and economic forecasters. They’re betting that the economy can stand up by itself, as the government cuts its budget and the stimulus programs gradually wind down.
Not that there isn’t plenty to worry about: high gasoline prices, unfinished revolutions in the Middle East, Japan’s nuclear meltdown, Europe’s ongoing banking crisis, simmering global inflation, and unsustainable U.S. debt.
If you had been able to foresee these events, you’d have rushed out of stocks many months ago – and you’d have been wrong. The market’s animal spirits, greased by stimulus from the Federal Reserve, kept propelling prices higher – up 25 percent since last September. Prices dipped in March, on the spike in oil prices, then rose again.
What the bulls see is rising numbers of jobs, stellar corporate profits, and inflation rising but not by enough to knock the expansion down. The U.S. currently looks like the strongest performer among the developed countries (Europe, Japan).
Market analyst Doug Ramsay, of the Leuthold Group, an institutional stock research service, thinks that stocks might be in a “bull market extension” – climbing 15 to 20 percent into 2012. He bases his forecast on Leuthold’s technical research into stock momentum.
Economist Lakshman Achuthan, a principal of the Economic Cycle Research Institute, sees “an accelerating phase of the business cycle, something that we predicted last November when many were still clinging to double-dip recession fears.”
There’s remarkably little worry about the impact on the total economy of slicing $38 billion out of federal spending authority. The budget passed by Congress this week hurts particular programs but is only a drop in the bucket of government spending – not nearly enough to give the economy withdrawal pangs.
There could be a positive reaction at the end of June, when the Federal Reserve ends its own stimulus effort. During a deflation scare last year, the Fed decided to pour $600 billion in extra reserves into the banks. The intent was to strengthen the economy, by making more money available for loans and lowering longer-term interest rates.
“On all counts it failed,” says economist Lacy Hunt of Hoisington Management, an investment advisory firm. Suspicious investors sniffed more inflation ahead, and interest rates (including mortgage rates) went up instead of down. Wall Street traders borrowed the money to speculate, piling up record increases in margin debt. Commodity prices boomed. Households now face higher food costs as well as the higher gasoline costs driven by disruptions in the Middle East. Spending on items other than gasoline stalled. Many factors affect prices, Hunt says, but the fed has been “aiding and abetting” the general increases.
When the Fed withdraws, Hunt expects these trends to reverse. Inflation expectations should ease, letting interest rates fall and easing the price pressures on commodities. Real incomes should improve. If these forecasters are right, your investment program should look like this:
1. Stay in your bond funds. If ending Federal stimulus moderates the pace of economic growth, inflation fears will ease and long-term interest rates will edge back down, Hunt says. He thinks that investors who are switching into short-term bonds are making a wrong-way bet.
Jim Floyd of Leuthold like high-yield bond funds, even though they’re not the bargains they were six months ago. A growing economy lowers their default risk.
2. Don’t be afraid of municipal bonds. Their tax-equivalent yields are still close to their all-time high. In February, scare stories about potential defaults set off tidal wave of selling. Investors have been fleeing muni funds at the rate of roughly $500 to $700 million a week, the Investment Company Institute reports. But the states are driving some tough budget cuts and tax revenues are going up, which reduces credit risk. “The problems are severe, the road is long, but the trends are favorable,” Robert Elsasser of the investment advisory firm, CTC Consulting, wrote in a recent report to his investors.
3. Keep the faith in stocks, including foreign stocks. In a “minefield of risks,” the economy has enough push behind it to keep profits and prices moving up, even if growth slows a bit, says Allen Sinai, chief global economist for Decision Economics. But over the long run, he sees international investors moving away from the dollar and the United States. “No sensible person looks at what’s happening in Washington and thinks that any way to run a country,” he says. Of his top countries to invest in, seven are in Asia (led by China), plus Russia (“a rich country and the world’s largest oil exporter”), Germany, Canada, and Australia. He is “underweighted” in the United States.
The hair in the soup might be oil prices. A temporary spike won’t have much of an effect on the business expansion, Sinai says. But a permanent new high would stall the economy later this year and into 2012. “The U.S. has not faced up to the problem of negative oil shocks” and the need for energy independence he says — another reason to invest elsewhere.
You might, however, take a flyer on nuclear stocks. Leuthold’s David Kurzman thinks that nuclear power won’t shrink, as an industry, despite the Fukeshima Daiichi meltdown. Nuclear remains one of the low-cost sources of electric power, he says, and some major countries (China, Russia, India) are adopting it. He sees good buys in the shares of nuclear service companies and uranium mines.
It’s said that markets climb a wall of worry, and the wall today is high. Something unforeseen could turn these forecasts over in a moment. For now, however, that’s where the consensus lies.
Tags: bonds, budget cuts, deficit, federal budget, stocks, the economy
Jane, there are those now writing about a bond bubble, as so many have moved assets into bonds, a very large amount of USA savings. some of those warn as the longer term bonds might see price loss and a lost value in equity. the last couple contacts I had actually suggested short term bond funds in preference to other options, since they are not subject to this strong down price pressure if this pressure or bubble is to blow. They think short term is more safe. If one is not already in bonds, is the short term bonds the place for today money, in preference to CDs or other fixed, etc.? It might not be as safe as CDs but its return is likely to be two to five times that of present CDs. Is this sounding accurate, from your view? jim
I can’t predict interest rates. Right now the Fed is still holding short-term interest rates down, so they are lower than what would normally be the case. When policy changes, short rates could rise faster than long rates, meaning that the market value of short-term bond funds would drop more than expected. But who knows? If this is must-have money, needed in the short-term, stick with CDs. If it’s long-term money, I’m still a fan of medium term bond funds, income reinvested.
This is perhaps a bit off-topic. I’m a fan of bond index funds for the fixed-income portion of a portfolio. But even Vanguard’s Total Bond Index Fund doesn’t include stakes in high-yield corporate bonds or TIPS as I recall. To what extent should a person, say, 10 years from retirement consider diversifying into these areas?
Total Bond at Vanguard includes some high-yield. There is a separate TIPS fund, which is a good diversification against future inflation risk, so a good place for part of a fixed-income investment.
J. now while the DOW is relatively high, is it a better time to buy into bond funds, are bonds cheaper when stock is higher? conversely, when DOW is low and market is down, are bonds more expensive in general or relative terms? when is a best time to buy bond funds. In buying stock or mutual funds on the low end of price range would seem better. Same with bonds, even with the lessor spread of that bond fund cost range?
Jim, you need to buy my book! All the answers to the questions you keep asking are there!
Dear Jane,
I understand the recent bull market is partially due to corporate buy backs of their stocks. Can you talk more about that issue? It has the air of corporate honchos rigging the system in order to increase their bonuses. Thanks.
Corporate stock buybacks can’t account for a market like this one. It’s running on high corporate profits, continued growth and low interest rates that make alternatives unattractive. I should add that a lot of investors like stock buybacks, too, because it provides continuing demand for their own stock. I think they’re mistaken. It would be better for these cash-rich companies to pay higher dividends and let investors decide where they want to put the money.