Money: Pecuniary Prudence

The year just past was pretty miserable for the economy, but ironically it was largely profitable for investors. Calendar year 1982 saw unemployment mount steadily and economic growth come to a standstill. Indeed, it went in reverse by one percent. But it was a good year, broadly speaking, to hold stocks, bonds, and precious metals. It was also a very good year for simply earning interest.

From the first trading day of January 1982 through the close of trading on December 31, the Dow Jones Industrial Average rose more than 19 percent, even after falling 24 points from its December 27 high of 1070.55. Other measures of the stock market reflected this fairly impressive performance. The Nasdaq Composite index of over-the-counter stocks also rose more than 19 percent, while the Standard & Poor's Composite rose 15.25 percent.

It was an even better year for bonds. As interest rates fell during the year, long-term government bond prices rose 24.9 percent through December 1, according to Salomon Brothers. High-grade corporate bonds rose 29.27 percent during the same period.

Meanwhile, those who did not want to take risks in stocks and bonds did very well just earning interest on deposits. Even after the collapse of interest rates in the latter half of 1982, rates of return remained quite respectable. At year-end, some money market funds were still paying over 10 percent, and at least one of the new bank money market accounts was paying 12 percent.

Precious metals also performed surprisingly well in a climate of diminishing inflation. Gold rose 15.2 percent, to $456.90 per ounce on December 30, after reaching $462.50 a few days earlier. Silver did even better, appreciating 35.7 percent over the year, to $10.90 per ounce. It had hit a yearly high of $11.20 only days before New Year's. At one point during the late summer, gold threatened to break through the $500 level again, but silver reserved its big push for year-end.

These performance statistics for different investments are all the more impressive and meaningful because of the dramatic reduction in the inflation rate over the past year. An inflation rate of 3.9 percent made the real rate of return on all investments higher.

Of course, not all investments did well. Most commodity prices suffered, as did real estate prices. Then, too, just because stocks or other assets rose by a certain amount from January to December doesn't mean that your particular portfolio did that well. You may have done better or worse, depending on what you bought and when. It was a year of dramatic fluctuations. Stocks, as measured by the Dow index, traded in a 300-point range. Gold fluctuated within a band of nearly $200 per ounce. They were treacherous but interesting investment waters.

Well, what about 1983? The one thing that this year will likely have in common with 1982 is a great deal of economic uncertainty and, hence, market unpredictability. But that's nothing new. Amid growing signals of economic recovery, the stock market at year-end seemed poised to ratchet up further—or collapse, depending on which analyst you listened to. Although the market had risen at one recent point by nearly 300 points since August, even the most bullish stock traders were reluctant to pronounce it a "bull market." Most people persisted in calling it a "rally."

Barely two weeks before the Dow jumped to a record high of 1070.55 in early January (since surpassed), the bulls seemed to be on the run, as the index plummeted briefly below 1000. Once again, the shorts were foiled, and the market rallied. But how much longer the bears can be held at bay is unclear. The watchword is caution.

Bonds could be the best bet if, as seems likely, interest rates continue to fall. High-technology companies, as well as companies that make building products, are good stock bets once the recovery gets under way in earnest and the bears on Wall Street are finally routed. The answer meanwhile is to stay liquid and balanced. There is still some good, low-risk interest to be made. Use the new, competitive (and insured) money market accounts to remain liquid. When you're ready to invest, take a balanced stance. Divide your funds among securities in different industries. Mutual funds are good tools for doing this. Stock options and, soon, options on stock index futures are a further way of limiting risks.

Precious metals are a crapshoot, short-term. Inflation is not likely to rise enough to make gold and silver really soar in the first half of the year, although political events around the world could. The Federal Reserve seems to be doing its best to reheat inflation, but the economy is too weak to permit that just yet. Longer term, however, precious metals at these prices will prove to be very good hedge investments—and maybe sooner than we think. If, instead of the "moderate" recovery nearly everyone is expecting, we get rapid economic growth (not difficult given the low starting point), we could see the beginnings of a new round of inflation.

The Federal Reserve's expansive credit policy encourages powerful market elements (business and labor) to increase prices as business and consumer demand picks up. Other stimuli include the Fed's aggressive lowering of interest rates and the advent, at last, of a real tax cut in July. The Fed will find it difficult to return to monetary restraint, even if it wants to, because of looming budget deficits, estimated as high as $200 billion. Monetary restraint under such adverse fiscal conditions would mean forcing interest rates back up and killing off the nascent recovery. For all these reasons, it's anything but clear that we are in a long-term disinflationary cycle.

It's not certain that inflation is going to accelerate late this year or next year, but it's a strong possibility. One advance indicator may be the recent strength of precious metals and "hard" foreign currencies. After several years in the doldrums, the tide may be turning back in favor of hard money.

Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.