The higher deficit, debt and interest rates don’t have to make you worried about the economy.
Pilgrim Don in Arizona sent me an article published in the Wall Street Journal that outlines what they think the climate is going to look like for investors in the coming years. It reports that this year’s deficit alone will add $1.6 trillion to our outstanding debt. That’s about $15,000 for every household in the country. Looks like the country just doesn’t know how to stop spending money. And let’s not stop there. Over the next 10 years, our debt will grow another $8.5 trillion because of the yearly forecast deficits.
What the #$% are we doing????
Are we defenseless against this deficit debt addiction? Does the Journal have it right?
Let’s take a look at what the Journal says. We’ll see if it makes sense and, if so, what you should do about it.
1. Don’t buy long-term bonds.
OK. I’ll agree with the Journal on this – as I’ve been telling people for a while now. As interest rates go up, the value of long-term bonds decreases as a rule, and with no room for rates to drop, the only direction they can go in is up. Look out above! This is why a government bond investment stinks.
So rates are going up as we see from this morning’s news.
Having said that, it’s certainly not a forgone conclusion that hyperinflation is just around the corner. Interest rates (and inflation) could stay low for quite some time. Many people even argue that we are in a deflationary cycle at the moment – a time when money supply is decreasing. People are saving more and learning how to get out of credit card debt fast. They aren’t spending. That would be counterinflationary. We have low interest rates right now in order to counter this deflationary cycle, they say.
It’s just plain weird right now. On the one hand, the deficit and debt are adding to financial stress on the system. Eventually, it’s going to cause inflation. But jobs are few and far between. Unemployment is high. People aren’t spending. That would argue that we need low rates to get the economy moving again. The definition of inflation is too many dollars chasing too few goods. Right now, we have lots of dollars in the system, but they aren’t chasing anything. Like I said…weird.
Bottom line: I still don’t like long-term bonds, so stay away from them.
2. The danger is nearer than you think.
I think I’ve addressed this already. We don’t know. Even (dare I say it) the mighty Journal doesn’t know when inflation is going to kick in because of the deficit and debt. Interest rates did go up today, but that doesn’t mean they’ll be shooting up overnight.
Don’t pay attention to people who try to predict the future. They are acting silly. They like to create financial stress for you so that you keep buying their paper. Chillax…but stay awake.
3. Make sure you are globally diversified and not entirely dependent on the dollar and the U.S. market.
OK…you already know that I believe in watching the market and moving money as the market dictates. I don’t believe in static diversification for diversification’s sake. It’s no way to protect your assets. That kind of investment approach didn’t help many people in 2001 or 2008. I believe that if you use an active approach, you should be willing to shift assets as the market demands. Being heavily invested overseas over the last several months would have cost you.
The paper goes on to suggest gold as a good alternative, and I think this is dumb. First, over the last several hundred years, gold has proven to be a terrible way to make money. Second, I’ve already answered the question, “Should you buy gold?” and my answer was NO. My favorite TV show is coming up (Law and Order) so I’m not going to write another 1,000 words on the subject right now.
It does make sense to move your investments as the market shifts, but it does not make sense to diversify heavily out of the U.S. market as a general rule – or just because the Journal says so. The market will dictate that – not the Wall Street Journal.
4. Maximize your tax shelter contributions.
I think this is good advice – but that doesn’t have anything to do with debt or deficits. They may as well have thrown in that it’s a good time to eat your vegetables too. Wealth Pilgrim – 3, Wall Street Journal – 1. Booyah!
Better advice? Consider mortgage unemployment insurance.
5. Share prices aren’t expensive; they’re just not cheap.
First, I don’t know what that means.
The writer argues that share prices are not cheap relative to the risk investors are taking right now. To me…that means they are relatively expensive. Why can’t he just come out and say so? Sheesh.
Now…is his statement true?
One way to answer this question is to look at price versus earnings. That is, a comparison of the price of a stock to how much the company earned. A high P/E ratio indicates an expensive market, and a low P/E ratio indicates that stocks are cheap.
According to historical standards, yes, stocks are a bit pricey. We are on the low end of what it’s been for the past 20 years, but we are still above the median.
I wish that the article referenced the P/E ratio because without doing so, it really doesn’t give the reader any context. We sort of have to take his word for it. I’m going to be fair and penalize the Journal another point and award myself two for pointing this out.
So that’s five for yours truly and zero for the WSJ. IN YOUR FACE! Yeah, baby…a shutout!
I believe that this period has its risks – like every other time for investors. We face unprecedented government spending, debt and deficits, but that doesn’t have to cause you financial stress. I believe that this is no time to adopt a fixed strategy based on your interpretation of current affairs. There are too many moving parts.
Let the market itself direct you rather than waste your time and money trying to getting ahead of the curve.
It is, and always has been, a time to remain vigilant. It’s important to be very clear about your long-term goals. Remember why you are investing and don’t forget about the risks you take by trying to time the market. Our little buddy from the Journal didn’t even consider that issue.
What’s your take? Are you putting everything in to cash? Going for gold? Pork Bellies?
P.S. This article is a bit longer than I thought it would be, so I’ll quickly mention that Best of Money Carnival awarded us one of the top ten posts for the week. Check out the other wonderful articles.
Pilgrim Don in Arizona says
5 zip over WSJ!
Great review, Neal! I appreciate you putting some sense, especially common sense, into some of the hype we read every day.
Financial Samurai says
Indeed, be scared of long term bonds indeed! That said, I don’t think the 10-yr yield will breach 5% this year, nor will the Fed even think to start raising the fed funds rate until 4Q10. Even if they did, it would be at max 50bps.. so whoopdeedo. It’s the 10-yr yield we need to be most concerned with… and that ain’t going nowhere!
Cheap money 4 life!
2 Cents @ Balance Junkie says
I agree that we don’t need to panic, and that every period has its risks. But (you could hear that coming, right?) I do think that the current climate presents elevated risks and I am managing accordingly by staying out of both stocks and bonds.
I do think that deflation is more of an issue than inflation at the moment, but for how long? I have no idea.
I agree that risks are elevated. I can understand why you’d be out of the market.
My only problem is that the market has a tendency to rise so being completely out is a bold move.
Time will tell….but best of luck to all of us!