Sent: 30-10-2012 14:37:03
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Big Picture Themes a Key to Investment Choice
The US ten year constant maturity Treasury bond yield going back to the 1950s points to critical investment decisions coming up very infrequently - perhaps only once in a generation.
Anyone looking at the accompanying chart of the US 10 year bond yield (here) has to be struck by the broad pattern: a 30 year rise in yields which reached a peak in late1981 followed by a downward trend which has persisted for another 30 years.
Every day we might check the latest rates and listen to the best known bond gurus prognosticate on the outlook for the next few days or the month or so ahead as though this might give us meaningful investment leads.
And, despite preoccupations with what Ben Bernanke's last utterance might have meant or whether a terrorist attack will send the global economy into a tailspin, non trading investors have only needed to make two decisions over the past 60 years, namely, to sell in 1950 and buy in 1981.
The lengthy duration of the trends in this market has both costs and benefits. If the tendency to long duration price adjustments are repeated, making the wrong call will leave an investor out in the cold for a very long time. The flip side is that there is ample time to adjust. There is no need to panic.
That said, the chart pattern highlights the importance of getting the big picture right. In this case, the big picture has been about inflation. Western economies spent two decades losing control of inflation before taming it again initially through two recessions in the early 1980s following quickly upon one another.
The need for aggressive anti-inflation policies gave way subsequently to the beneficial effects of global productivity improvements as the primary source of downward pressure on prices.
Technology advances and the expansion of the Chinese manufacturing base in the 1990s were important ingredients. So, too, were freer international trade conditions which allowed manufacturing industry to relocate to lower cost environments, create economies of scale and export. Falling goods prices or the rising quality of the products being marketed removed pressures to seek higher wages to sustain living standards.
Of course, 30 years is a long time and we are left questioning how much further there is to go. The broad consensus among analysts is that there is probably not much downside to yields. Monetary expansion at a rate well ahead of output growth in all the largest economies is prompting fears of an inflation outbreak. To a person, strategists are warning of this eventuality.
There is a parallel in the current inflation fears to the attitude of forecasters through most of the last 20 years. Even as yields were continuing to fall as markets anticipated continuing downward pressure on inflation, forecasters were preoccupied with inflation accelerating.
A bias toward keeping interest rates as high as possible until a demonstrably detrimental effect on employment was evident characterised most monetary policy settings over the past two decades.
Today, inflation fears persist even as global economic growth slows and unemployment in the advanced economies is high or rising. And, yet, the US bond market is continuing to say that this should not be a problem.
The benefits of technology continue to flow. Some of the newly created manufacturing centres such as those in China are losing competitiveness but large reservoirs of underemployed labour can be tapped in Africa, South America and other parts of Asia.
An unexpected renaissance of US energy production has even created the possibility of North America reclaiming a share of world manufacturing activity as it matches newly found sources of relatively cheap energy with a large resident market, a growing labour force and technological knowhow.
The US bond yield history poses two challenges for investors: firstly, to minimise the influence on their thinking of the daily news cycle and, then, to work on picking the next big theme that will dominate outcomes for the upcoming generation of investors.
The latter is easier said than done. Most likely, it will only be recognised once it is well underway.
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