George Haligua speaks about Inflation, Cycles and Toothsayers

When the Federal Reserve was reducing short rates in 2002, there were rumors that the nominal rates would drop to one percent, which they did along with real yields going into the negatives, which they still have not yet recovered.

[ClickPress, Tue May 03 2005] When the Federal Reserve was reducing short rates in 2002, there were rumors that the nominal rates would drop to one percent, which they did along with real yields going into the negatives, which they still have not yet recovered. Of course financed based corporations increased their profits margins and gained notable cash flow increases which in turn made the Dow 5000 level of value almost obsolete, fortunately stocks endured the declines.

It is only obvious that the increased profit margins and the notable cash flow increases were due to lower yields, but as the nature of forward earnings are unpredictable, we must look on how to steer clear of the Dow 5000. The only reason we are higher than the Dow 10,000 is because of more predictable interest rates, they dropped and will stay low. One needs to understand the full story of disinflation.

When inflation dropped to rock bottom, bringing everything else with it, such as interest rates, several repercussions happened. Price investors were ready to disburse for future incomes if they had expanded which of course would make them available at a discount with the dropping interest rates, which in-turn made bond prices go on the rise. When disinflation reached its base, future returns started to be compared to current true interest rates. Predicted future inflation rates are close to 5 percent, resembling the power that real interest rates had on asset pricing such as real housing appreciation, which can go either up or down during periods.

However real appreciation and depreciation are related to periods of low and high interest rates.

This method of reduction is what assisted in steering clear of the Dow 5000 and made the Dow 10,000 the real mover for the recent gains in prices for homes. If one can be loaned cash at extremely low rates, then it is important how high home prices, bonds, stocks, commodities would go as they are all fixed on the same standard of interest rates. The truth is that real interest rates have increased almost all asset prices due to these low-level interest rates. The levels of today have created double-digit yearly appreciation rates for all the different asset classes on variable cycles, which stocks and bonds are first in line.

In order to see clearly for the future one has to understand that real yields, in whichever form they may appear dropped two years ago, but have been on the rise, so the declining trends are over and a new cycle, grant it being a small cycle, has emerged. This new cycle will in the end reduce stock P/Es and bond prices and make all other asset classes appear very dull.

In conclusion, one has to see the reflection of increased inflation and demographic stresses, for example, as the stress rises so will housing prices. Taking the assumption that current market valuations and one to two percent real earnings growth are true, then stock prices will gain. We are at the end of the spiraling interest rates, the new cycle has once again begun, but be careful, as the predictions are that real yields will stay low and all asset classes are pegged at two to three percent for real and a minimum of 5 percent for nominal returns extended over lengthy periods, one must be careful, no one knows the future, ensure your high quality bonds are sheltered by inflation so if need be, you will have the protection against wrongful toothsaying.

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