As the US economy becomes more complicated and unpredictable, thanks in part to political vicissitudes, investment strategy is also becoming more difficult. The locus of most of the uncertainty (and the compass of nearly all markets) is interest rates. The ubiquitous price/yield of money, more than any other factor, determines the general direction of stocks, bonds, commodities, currencies, and real estate. And no one really knows where they're going.
Henry Kaufman, the sage of Salomon Brothers, thinks he knows, and everyone on Wall Street listens to him. He says interest rates are headed back up to their previous record levels or beyond, having fallen nearly 5 percent from their summer 1981 highs at one point in December.
Others, including this columnist, disagree. Kaufman's prognosis "just doesn't compute," asserts William Miller, vice-president of Crucible Securities in New York. "If the market is going to hell in a handbasket because we're going into a recession, how in hell can interest rates go up?"
So much depends on government economic policy—in particular, the interaction of fiscal and monetary policies. If fairly conservative projections of a $100-billion fiscal 1982 budget deficit and a $150-billion fiscal 1983 deficit come true, then seemingly almost any method of financing them will tend to put pressure on interest rates, other things being equal.
Strict reliance on the private capital markets by Treasury, which could drain off at least one-third of available private capital, would, in simple supply and demand terms, tend to drive up rates. But even resorting to the accommodative open-market facilities of the Federal Reserve would not guarantee lower rates. Indeed, the inflationary expectations that would result from Fed money creation might drive interest rates higher than otherwise.
It now appears that the Fed—which, despite a few lapses, has done an admirable job of reducing monetary growth and thereby laid the groundwork for both lower inflation and lower interest rates—will not fully accommodate the Treasury's financing needs. Naturally, it will come under increasing pressure to do so. If Paul Volcker and company do hold a steady course, and if other pieces fall into place, then it is likely that the upswing in rates early in '82 will prove temporary.
For one thing, because of the recession, private credit demand is off and should further decline. Then, too, there is every reason to expect that the private savings rate—now at a disappointing 4.9 percent—will increase throughout the year, although it is unlikely to approach the administration's goal of 8 percent. Finally, it is unlikely that the budget deficits will come in as high as projected. There will be more spending cuts and, unfortunately, new taxes.
By year-end, the beginnings of economic recovery should begin easing the deficit strains for fiscal 1983, although the revival of private credit demand at that point should give a fresh boost to interest rates. With this admittedly debatable forecast in mind, what is the outlook for various investments?
Stocks: For the better part of the year, general market conditions look bearish. This is particularly true of the Big Board—the "blue chips," The Dow Jones index could dip to 700. Shorting the shares of large, heavily institutionally held companies should prove profitable. But don't be greedy. Ride them down a few points and get out.
Use your profits to buy up some of the promising second-tier stocks, many of which are at attractively low prices. Look at up-and-coming companies involved in data transmission, laser technology, robotics, and the like. On foreign markets, even companies in rapidly growing areas, especially the Far East, have been hit by worldwide recession. Selective purchases of foreign securities—or foreign unit trusts—look good for long-term growth.
Bonds: Assuming an eventual decline in interest rates, bonds may soon be due for a long-awaited rally. Miller suggests buying 20-year, high-grade, deep-discount corporate bonds with open and active sinking funds. Bonds issued 10 years ago at 6 percent must now be sold at a 50-percent discount to compete with newer issues. Therefore, according to Miller, you can buy $1,000 worth of bonds at $500. You can hold until maturity for a long-term capital gain or sell out at the market when lower interest rates increase the value of the bonds.
Commodities: Commodities have been hit perhaps worse than any other investment by recession, disinflation, and to an extent, tax-law changes. It may be some time before we again see the kind of wild bull markets of the last decade—unless the Fed reverses course and revives inflation. But the coming economic recovery should give a profitable lift to all kinds of commodities; for example, lumber, copper, silver. Gold, for now, should be relegated to relatively small cash positions as the ultimate hedge. Since we don't know when the recovery will come, the best tack is to buy positions in distant delivery months, then watch and wait.
Currencies: Right now the dollar is the reigning king of the hard currencies, blessed by declining inflation and relatively high interest rates, giving it the highest real yield around. But as interest rates come down, the dollar's edge will dull, particularly if inflation begins to rise again. Although the European currencies and the Japanese yen made a recovery in the fall, they have since slipped back. They are all far below their 1978 highs and must be considered undervalued. As the Polish crisis recedes from memory and as the European economies gradually pick up steam later this year, the Euro-currencies should gain. The yen has better immediate prospects.
IRAs: Before signing off, a few obligatory comments on the latest rage—Individual Retirement Accounts. There are three prime considerations: How far are you from retirement? How much taxes will you really save? And what else could you be doing with the money?
IRAs probably make sense for a good many people, but beware of locking your earnings away over a long period of time in instruments that may or may not fare well in the uncertain financial environment of the future. The best route is a self-directed plan or a plan that will allow you to shift among mutual funds to get the best available return.
Steven Beckner is a free-lance financial writer, the assistant editor of World Money Analyst, and the author of The Hard Money Book.