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What the Markets Are Telling Us About the Economy

Published on: Aug 18 2020

Investment markets often tell us more about the economy than the economic data.These days, trends have changed before most of the standard economic data are reported. Plus, the data often are incomplete or based on estimates because so many businesses and government agencies have been fully or partially closed.

The markets can give us a more timely and accurate reading of what is happening in the economy.Take a look first at the bond market, especially the U.S. Treasury bond market. As one of the largest investment markets, the treasury market reflects the expectations of a wide range of investors.The Federal Reserve is holding short-term interest rates low but has less influence on intermediate and long-term rates.

Those rates better reflect investor expectations about economic growth and inflation.Recently, yields on the 10-year and 30-year treasuries tumbled again. The rates had been rising following the resolution of the credit crunch in March.But they reached a recent peak in early June.

As coronavirus cases spread, talk increased about the potential for a renewed reduction in economic activity. Interest rates often fall in anticipation of slower growth.The yield on the 30-year treasury bond tumbled from 1.68% on June 5 to 1.20% on July 31. The 10-year yield took a similar plummet.Commodity prices are another good market to follow. They can serve as advance indicators of growth or inflation.You’re probably aware of the big move in gold this year. The metal set a series of record highs recently.

In fact, during the last month and for the year to date, gold has higher returns than the Nasdaq 100, though the Nasdaq 100 still is a bit ahead over 12 months, 45.58% to 39.74%. A rise in gold often means investors anticipate higher inflation and a weaker dollar.

Broader commodity prices also indicate prospects for inflation and economic growth. Commodity prices declined the last few years, but they started recovering recently.

The iShares Com-modities Select Strategy (COMT) exchange-traded fund is up 15.27% during the last three months. That hints investors are anticipating higher inflation and perhaps modest economic growth.Treasury Inflation-Protected Secu-rities (TIPS) are another good market indicator of inflation.

After years of stagnation, TIPS steadily increased in 2019 and are rising faster in 2020.The iShares TIPS Bond (TIP) ex-change-traded fund (ETF) is up 8.90% so far this year. That’s a big move for the fund.

Taken together, the markets warn us to be prepared for something we haven’t seen for a while: stagflation. You might remember stagflation from the late 1960s and the 1970s. It is a combination of weak economic growth (stagnation) and higher inflation.

It is not a sure thing that stagnation is on the way, but it is a good probability. I have pointed out that the Federal Reserve is going to keep buying securities, increasing its balance sheet and providing the markets and economy with liquidity.

The federal government also is likely to keep providing stimulus for households and businesses for as long as the pandemic is stifling the economy.

The effects of the pandemic and the continuing economic damage from the financial crisis are obstacles to strong economic growth. But the stimulus measures, especially the Fed’s monetary policy, put upward pressure on inflation.

In fact, the Fed and other central banks would like to see higher inflation.The result of the two sets of forces is stagflation. Of course, stagflation isn’t a sure thing. The stimulus measures or the end of the pandemic could boost the economy. Whatever happens with the economy, higher inflation is looking more likely at some point in the next few years.

The prices of gold and TIPS are forecasting higher inflation.We added gold to our portfolios a couple of years ago, before most investors recognized the potential for higher inflation. Now, we’re adding TIPS to our portfolios. We’ll hold our stock positions until an economic downturn seems more likely.

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