In normal times stock prices usually fall when interest rates rise, a currency loses value when large amounts of it are put into circulation, and bonds are an investment that is safer than equities.….
We are not living in normal times. The central banks, namely, the Fed, ECB and BoJ, have conspired to buy bonds that a sane investor would eschew, and they have created a ZIRP/NIRP environment with their purchases of debt paper that has completely distorted the bond markets.
The US dollar continues to rise in value, defying economic logic that would suggest that the value of the US dollar should fall due to the huge national debt that is now 106% of GDP and a huge trade deficit of 40 to 50 billion dollars a month. A contributing factor to dollar strength is that the rest of the world is in such a mess that the US dollar still looks good in comparison with the currencies of other economies. The Fed is expected to raise rates in December, and that will mean at least 25 bps with further rises probable in 2017. The result is that money has started flowing in the direction of the US in anticipation of higher returns for debt paper. At the same time the stock market has marked up record highs and seems to be promising even better results as investors shift capital from bonds to equities.
It therefore seems that the best current strategy is to invest in equities quoted in US dollars. The fact is that equities are currently very expensive with investors scrambling to avoid US Treasuries that have 30 year paper now yielding 3%. Energy stocks went even higher thanks to the purported agreement reached by OPEC and apparently seconded by the Russians, who say they will cut production. Of course the American shale producers will quickly step up production once the oil price reaches US$ 50 or more a barrel.
If one looks at the default rates for high-yield corporate bonds, they are rather high, especially in the energy sector. This is, however, where investors can still get reasonable returns if they select solid companies with issues soon to mature. As for overly expensive equities, it is still possible to find stocks of solid and well-managed companies trading at or under book value. Warren Buffet and intelligent investors like him are looking for these stocks and buying them. The problem is to find these stocks and purchase them before the price goes up further. What this means is that stock selection has become all that more difficult due to market distortions.
Furthermore, rising interest rates mean more volatility in the markets and strong shifts in bond prices in the secondary market. At a certain point equities will be subjected to pressure as investors start to turn to bonds that produce decent yields. Members of the Doom and Gloom Club are always predicting apocalyptic stock market crashes and eventually there are painful corrections. At the present time it looks like it is going to take some time for the balance to shift back to the bond market, which presumes that the central banks will refrain from eliminating price discovery. If they do not, then market forces may wreak havoc with their NIRP and ZIRP policies.
The rich get richer, and the poor get poorer. It is doubtful if Mr Trump will be able to reverse the situation when he is confronted with a financial crisis not of his making. All the uncertainty adds up to creating an extremely difficult market for investors to make wise decisions. The best advice is to invest defensively and avoid speculation in such an environment. Gold is extremely cheap as the market price is close to the cost of production. It is a good time to buy gold.