Wednesday, January 18, 2006

Beware the Next Recession?

I was reading an old article on the Economist magazine, where I was lead from a blog post I was reading. The article was written in late September 2005, and concerns global inflation. This passage really struck a chord:
The real worry with rising inflation expectations is less that they herald a surge in inflation than that they will limit the ability of the Fed or other central banks to cut interest rates if growth stumbles. It is commonly argued in America that if the housing bubble were to burst, and falling house prices threatened to choke consumer spending, the Fed would slash interest rates to prop up the economy, as it did after the stockmarket bubble popped in 2001-02. But then inflation was falling. Today, with inflation rising, the Fed would no longer have that option. If the economy hits trouble, investors and homebuyers should not expect to be bailed out again.

Combine that with the very real possibility of a slowdown this year, based on many indicators, and a recession may be a lot more brutal than the one we had starting 2001.

What is the solution? Well, prepare for a shakedown by making yourself indispensible at work, save for a long rainy day (the rule of thumb is 3-6 months of living expenses) and consider some prudent investment choices, including defensive stocks, and inflation-protected securities, notably I-bonds. I'd still invest some amount of money in investment-grade bonds, since a global economic slowdown may dampen inflation and allow a reduction of interest rates.

For those unfamiliar with them, I-bonds are US Treasury savings bonds, that offer a fixed interest rate over the present inflation rate, and currently yield about 6.73%. You have to hold them for a minimum of one year, and are penalized some interest if you withdraw them in under 5 years. You can learn more information on them here. You can purchase I-bonds without commision on the TreasuryDirect page, and can also schedule regular electronic transfers from your bank account in amounts as small as $25.

This may also the place to note that some value-based asset allocation models favor trending down to closer to a 50-50 stock-bond allocation for someone in their 30s (based on present valuations), and a greater proportion of bonds for older employees. Recent history has played a role in much of the exuberance about stocks, but there is some clear evidence that outperformance of stocks over bonds in the past isn't close to a sure thing for the future, at least not to the same degree.

1 comment:

krish said...

America the biggest polluter of the planet, if it enters koyoto in the proper way it will get into a huge recession. they should rightly so.Instead of dodging they should sign the koyoto. they talk so much about their responsibility for the world etc. where is their responsiblity in this.

The planet/other countries are paying for their polutants. highly unfair.

American govt is pretty much protection of business and pride, not a pinch of anything else.