I am sure you might be wondering why the Market and Asset Prices are surging despite the troubles.
Coronavirus is still spreading, there are very few green shoots, people are losing their jobs, GDP figures don’t seem good and yet the markets are rising. What does this mean for the nation’s economy — and your money?
- The interest rate in the U.S. is close to 0% now.
- The Federal Reserve (Central Bank of the U.S.) is printing money to fund the expenses of the government and it is also purchasing private bonds in the debt market. Startling is the fact that it is also purchasing non-investment grade bonds. REMEMBER, the Fed can provide liquidity but not solvency 😛
The question is, what is happening with the liquidity that is being injected into the economy?
- This money is not going into the production of Goods & Services (since demand is low due to COVID) and returns on bonds are close to 0%. The only alternative left with this liquidity is to invest in the equity markets and hence the markets are at record highs and going higher day by day.
It sure is a bubble, but when will it burst?
- Until the elections in November, things will continue to be the way they are, undoubtedly because of the political environment.
By delaying and continuing to print money, the deficit will only increase. Still, this deficit will have to be funded at some point of time either through reduced spending, higher taxes or the worst thing being inflation (which is nothing but by imposing a tax that a common person might not necessarily understand or realise). These measures will suck liquidity out of the system and at that point, at too high valuations, the markets will no longer have buyers. Thus, it will be headed towards a good correction. A correction in the U.S. will lead to a correction in India (and many other emerging markets).
The problems and the crisis will even worsen if there is inflation, and there isn’t any room to control it. Debt levels are already high, and even an increase in the interest rate from 0.5% to 1% is a 100% increase which could lead to a rise in defaults on debt.
How can this be “un-worsened”?
In terms of a solution, the best I can think of is what Ronald Reagan and Paul Volcker did in the 1980s, which is shrink the government budget. It will lead to a slowdown in the economy but it could avoid a more massive crisis. Obviously, it will require a lot of political will.
These events may lead to a loss of confidence in the U.S. dollar, especially as a reserve currency. This, combined with the rise of China, will raise questions on what should act as a reserve currency in the world.
As an investor, what should you do to protect yourself?
– The only alternative to any particular country’s currency is ‘GOLD’.
– Holding U.S. dollar-denominated cash or bonds is suicide since inflation or currency devaluation (both being likely) will destroy its value.
– A bond or fixed deposit is a bet on the currency in which the bond is denominated since it is a promise to pay a certain amount of currency (principal and interest) at specified periods.
– My strategy in terms of investment in the current environment would be to include not more than 20-25% of gold as a hedge in your portfolio. Gold prices will continue to appreciate from current levels since the demand from central banks throughout the world to increase their gold reserves will drive the prices upwards. Wait for the financial markets to become rational/correct and then allocate large amounts to equity once the correction takes place.
- The events mentioned above will vary to some extent in their timing and magnitude in reality due to the contingent nature of events and the various forces which direct these events.
- These views are my personal views based on my own research and understanding of the subjects involved. You are free to have your own opinions/views and take decisions that in your best interest.
- My actions & decisions are in no way contrary to my opinion mentioned above. In fact, I am looking forward to the market correction.
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