Thursday, February 10, 2005


Often times good news turns out to be bad news for the stock market. The main reason is that the stock market does not like inflation and good news often implies a strong economy and eventually a high inflation rate.

The CPI index has crept up for the past several months. It has gone up fast enough such that the 6 increases in the discount rate have not increased the real or inflation adjusted discount rate. Short rates are just as low now at 2.5% as they were a year or more ago at 1%.

What is the good news?

The good news is that the increases in short rates are having their desired effect. CRB Commodity Futures prices are moving down and US Bond Futures are moving up. Both are signals of lower projected inflation rates. Indeed spot prices of industrial metals peaked a few weeks ago. Gold, Aluminum, Copper and Steel are all trading down. In the bond market, the long maturity bonds have zoomed in recent days.

Oil is being followed closely by most investors but is it on the way up or on the way down? The per barrel price hit $55 last summer but in the past few days the price has bounced to either side of $45. It does not have to move up much to spook the markets as was evidenced yesterday.

No doubt it is not just the inflation rate that is slowing. The quarterly chart of GNP shows the growth rate of the US economy has slowed for 6 months. The big drop in bond rates implies that the slow down has continued.

In a file around here somewhere, I have numbers that show if an investor were smart enough to avoid stocks and bonds when the inflation rate was moving up at a strong pace, he would be a very wealthy investor. The sad thing for small investors is they tend to avoid stocks at just the wrong times.

For the past three years, the average small investor has sold more stocks than he has bought. Cash reserves went to record levels while the markets were very good. Only recently have bank deposits and money market accounts owned by individuals come down in aggregate. Americans have about $1 Trillion dollars in extra cash flow and many have no idea what to do with it. A friend of mine says his experience is that if you give your money to a broker who sounds like he is much smarter than you about money and you let him trade it how he thinks is best, it will only take him two or three years to lose it all.

Americans are now annually withdrawing a net of about $300 million from pension funds. As baby boomers retire, this number is going to grow. Many of these withdrawals are required. The boomers will spend a lot of the withdrawals but they will reinvest large chunks. Will they put the money in taxable bonds earning less that 4% or dividend paying stocks that appreciate in value income tax deferred?

Beat these guys to the punch. Invest your money in stocks while they are relatively cheap. The lower long-term interest rates show the economy and inflation are slowing. This means short rates do not need to be pushed much higher. Low interest rates boost corporate profits and stimulate the economy. Stocks increase in value. The cycle repeats. For now the good news is good but it is up to you to take advantage. If you need a little guidance, let me know.