What is going on? Volatility is back. The oil market is collapsing. Europe may fall apart. And stocks seem set to move sideways. Pundits are claiming the bubble is about to burst. And stocks are trading at a multiple of GDP not seen since the early 1960’s. Below are some recent stories that caught my attention:
- Fed pressed ahead with plan to raise rates as it debated guidance: The Federal Reserve seems set on tightening policy even though inflation is low.
- Investors Freak As Saudi Inaction Could Sink Oil To $20 A Barrel. Time To Buy?: Oil is down, and Saudi Arabia seems unlikely to produce less to stop the slide. Thought Fed money-printing was driving a bubble in oil prices? Think again…
- Oil fears drive investors into long-term Treasurys: Fear is returning (did it ever leave?). If investors are willing to tolerate 1.9% interest rates for 10 years, what does that mean for inflation expectations?
- Bears Missing in S&P 500 Forecasts as Stocks Get ETF Cash: Everyone seems bullish. This is somewhat worrisome as when others are greedy, we should be fearful.
- The euro zone slides into deflation: If US monetary policy is on the tight side, the Euro zone is doing terribly. But Germany won’t listen.
- Are German schoolchildren taught about the 1929-32 deflation?: If only Germany would heed the right lesson.
- Level Target Now: Scott Sumner from themoneyillusion always has keen insight on where monetary policy should go.
What do all these stories add up to? The Federal Reserve seems set on 2% inflation and “normal” interest rates. But as the Euro zone shows, raising interest rates too quickly means deflation. We’re not completely out of the woods yet, as 10-year treasury yields and oil prices show.
What does this mean for stocks? In the past, loose monetary policy has mean higher interest rates and lower stock prices. Just like bonds, stocks are a security whose price is based on opportunity cost. Now, with monetary policy relatively tight, interest rates will remain lower longer, and stock prices will remain inflated relative to GDP.