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At this time of year, elaborate forecasts for the economy, interest rates, inflation and the future level of share prices, appear widely. Are they of value? The track record for forecasters is notoriously poor. As a group, they failed to forecast the last two years' downturn in stock markets, they believed interest rates would change little or go up and they told us to expect continued economic growth.
Is it likely that a forecaster employed by a securities house will tell you to sell and walk away? To what extent do vested interests impinge on the objectivity of advice? The question has to be asked.
From 1975 to 1982 the general trends of both interest rates and share prices were up. From 1992 to 1999 interest rates went down while share prices went up. In 2000 and 2001 interest rates went down and share prices went down. This little potted history suggests there are at least five more years to go in which interest rates and share prices fall together: so much for the "lower interest rates are good for everything" school of thought. Have lower interest rates solved anything in Japan? Indeed, you might care to think about the fourth possibility - if interest rates rise, stock markets could go down even more? **.
As for economic growth, it seems to us to be built on sand. Consumers may appear to be riding to the rescue, but they are borrowing more and more at interest rates way above the level of inflation in order to do so. Argentina got into trouble as a nation by borrowing too much, while in Japan the spending of the 1980's has long given way to a prolonged consumer retrenchment.
The reality is that such "recovery" is highly artificial and can unwind rapidly. Markets are telling us all that instability is now the norm. If you want to ride the rollercoaster as it turns down again, follow the forecasts and don't shilly shally on the way. If you want to hold on to your capital and income as deflation spreads from Japan and Argentina, then our contrary advice to invest in UK Gilts and US Treasury Bonds is the route to take. The choice is yours.
** It is our view that interest rates will not rise seriously for long, precisely because of the risks to the economy. Any rise would be quickly reversed. The fourth combination is included here for completeness. Reports that the Bank of England intend to put rates up should be treated as news management (unless, of course, you believe the authorities are clueless).
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© Kauders Portfolio Management 2002