Investing in financial markets is never simple, because the future is unknown and to some extent unknowable. That is why prudent investors, with sufficient assets, diversify their portfolios across a wide range of assets. June 2013, however, is especially complex. Two key changes in the market environment currently impact on investors’ thinking.
The first is the increasing volatility in the market for government bonds. For several years, holding these assets has proved beneficial, despite, or rather because of their declining yields. Because bond prices move inversely with bond yields, declining yields have manifested themselves in swelling bond values in investors’ portfolios. Declining yields are primarily a consequence of Federal Reserve policy to engage heavily in open-market activity, expanding base money by purchasing long-term government bonds and high-quality mortgage securities. This activity is now in its death throes, and no one knows how much a reversal of this activity will impact government bonds. The market anticipates the likely direction, so bond prices are falling and bond yields are increasing. To dump or not to dump is now the $64,000 question.
The second is the apparent end of the long-period of advance in the price of gold, especially marked since the 2008 financial crisis. From a peak in the region of $1,800 per troy ounce, gold prices have now crashed through the $1,400 per troy ounce barrier. Since gold offers no return other than through price changes, only gold bugs are now confident in retaining this precious commodity in their asset portfolios.
Well stocks are doing well are they not, with the DOW up by 16 per cent so far during 2013. Yes, but how much of that rise is underpinned by a Bernanke bubble, one may legitimately inquire. If Bernanke were to announce tomorrow that Q. E. III is over, just watch how dramatically the Dow and the S & P would sink. Probably not to September 2008 levels, but enough to cause stockholders some sleepless nights.
Certificates of Deposit offer little more than a zero yield, and the money market offers even even less. The realty market is still wobbly and corporate bonds surely would move in sympathy with Treasury bonds. Not much out there for the risk-averse investor.
So portfolio diversification surely is appropriate, with a little less in government bonds and commodities and a little more in stocks and high-quality corporate bonds. Even TIPS are now suspect, because, in the absence of significant inflation, they fare as badly as regular Treasuries in a rising interest rate environment. Still, those nervous about inflation should keep some TIPS in the bag. Those really worried about inflation should perhaps hang on to some gold.
Fundamentally, unease hangs over financial markets because no one fully understands how negatively Bush/Obama socialism will ultimately impact on U.S. economic growth. Growth is lukewarm at best, especially now, four years after the trough of the recession. Is this a short-term downturn, to be overwhelmed eventually by powerful private market forces? Or is it the new norm for an economy that has drifted significantly away from capitalism to a social market economy? That is the $1 million question.