What stocks to invest in = interest rates and economic growth « PRACTICAL STOCK INVESTING

What stocks to invest in

Over the past few days, I’ve written about two approaches to the question of the appropriate level for interest rates.

fixed income as an investment on its own

The first considers fixed income as an investment, with no reference to current economic conditions or to use of rates as a government policy tool.  According to it, holders of short-term fixed income instruments receive protection against inflation + a small real return; holders of long-term instruments receive inflation + a real return of 3% or so + an extra return if the instrument carries higher risk.

rates and economic policy

The second looks at short-term interest rates as a tool of economic that aims at steering growth along the preferred path of a given nation’s government.  The monetary authority slows the economy down and speeds it up by raising/lowering rates as circumstances dictate.  In the US, the recent preferred metric for judging success has been the employment figures.

quantity of money

There is a third, admittedly subjective, approach to this topic, one that many professional investors have traditionally used to gauge the tone of financial markets.  The idea is that the economy requires a certain amount of liquidity (i.e., money) in order to operate efficiently.  This is to maintain inventories, pay salaries and fund new investments.   It operates best when it has precisely that amount.

In a period like the current one of continuous radical supply chain and financial innovation, it may be hard to judge when too little money is available, and therefore activity is constrained and rates are too high.

On the other hand, adherents to this idea think that when money is too abundant, the excess inevitably finds its way into economically destructive financial speculation.  The signs that rates are too low are easier to spot:  soaring housing prices, bubble-level stock PEs and high-risk, nevertheless covenantless, junk bonds.

recent financial market worries

This third idea is the basis for the recent conversation in financial markets that ultra-low interest rates have passed their best-by date and are now doing more harm than good.  The strongest evidence that this is the case is in the junk bond market, I think.  However,  if there’s speculation in one corner of the financial markets, it must also be at work in the others.

– What stocks to invest in


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