‘Inflation is the most capricious of economic variables and central banks are cursed with the responsibility for it. It has defied all predictions in the US during the past five years and, once again, inflation’s general perversity is complicating life for the Federal Reserve.‘ – Financial Times
The US Federal Reserve board members are wearing a puzzled look right now.
Despite the tens of billions of dollars the Fed has pumped into the market, prices aren’t rising as much as the Fed had hoped.
In fact, according to the FT, US inflation is only up 1.1% versus the Fed’s objective of 2%. And you thought it was a good thing when prices don’t go up.
Not if you’re a central banker.
But if the Fed board members are puzzled by the low inflation rate, new member of the Money Morning team Vern Gowdie isn’t. Later on, Vern reveals the reasons for the low inflation number and what it means for the markets.
To give you a clue, it starts with a ‘D’ and it’s bad news for banks. But before that we’ll take a different slant on the issue and explain why this news confirms our view that stocks are on the verge of another super-rally…
We’re sure you remember the hullaballoo about a bond market crash and rising bond yields.
It was only a few weeks ago. Not only did the bond market crash, but the stock market crashed too.
The reason? Most folks (but not your editor) thought US Federal Reserve chairman, Dr Ben S Bernanke was about to raise interest rates.
As most investors know, generally, higher interest rates are bad for stock prices. But why is that?
There are two reasons why share investors don’t like higher interest rates.
First, higher central bank interest rates usually mean higher bank deposit rates. If banks can pay more interest on deposits it means investors may prefer the safety of a bank account compared to the comparative risk of a share investment.
And second, higher interest rates are bad news for companies with large borrowings. The more the company has to pay in loan interest repayments, the less there is to feed through to the company’s profits.
That’s why stocks collapsed a few weeks ago. The collapse came after the recent surge into dividend-paying stocks. Any chance of rising bank savings rates could have put paid to the dividend rally and therefore cause stock prices to fall.
Even though there’s absolutely no chance of the US Fed or the Reserve Bank of Australia (RBA) raising interest rates, investors weren’t about to take that risk. Hence falling stocks.
While it’s frustrating to see stocks fall for no reason, it also created an opportunity. We told Australian Small-Cap Investigator subscribers to ignore the fear-mongering and use the lower prices to buy good stocks – especially any beaten down dividend payers.
In fact, while most investors looked for an excuse to get out of the market, we explained to Australian Small-Cap Investigator subscribers that we were raising the buy-up-to price on eight of our stock tips.
Our reason was that stocks could surge again and we wanted to make sure they could get in on the action if we were right.
And so far, things have gone to plan. Stocks that took a pounding just a few weeks ago are now back to or near their pre-crash levels. We feel sorry for the worry-warts who didn’t stay the course and who probably sold right at the bottom.
But while they may feel bad about that after seeing the market rally, it’s not half as bad as they’ll feel if they don’t buy back in now…before it’s too late.
Our view on the direction of this market is the same as it has been since late last year. It’s a great time to buy stocks as the Australian market climbs towards 7,000 points.
But as we’ve also warned you, don’t expect the market to go up in a straight line. The market never does that. It always pauses, and sometimes falls before going higher.
That’s when nervous investors tend to bail out fearing the rally is over. Our guess is the Australian market is in that phase now. After the big rally from late June to mid-July, the market has gone sideways over the past week.
This is the bail out time for the impatient. But it’s also the perfect time to get in if you missed the recent run up. As we see it, there is absolutely no danger of interest rates going up anytime soon.
Remember, Japan has had zero percent interest rates for 20 years. What makes you think the Fed will start raising rates after just four years? The same goes for the RBA.
Most people haven’t figured that out yet. They think this is a short-term problem and that rates will go up again soon. That’s not happening, so get used to it.
So if we’re right about that, think of the logical conclusion. If higher interest rates are bad news for stock prices, then lower interest rates should be…good news for stock prices.
All it will take is for most investors to catch on that this low interest rate period will last for years and buyers should push the market to a record high before you know it.
OK, nothing is certain. That’s why we don’t want you investing every last cent in stocks. But we’ll be blunt. If you still don’t have exposure to stocks, or you’re not adding to an existing portfolio now, we fear you’ll come to regret it two years from now when the Australian market hits 7,000 points.
Cheers,
Kris+
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