INVESTING: Rising interest rates not a reason to get defensive

Investors the world over are in an uproar about the increase in U.S. interest rates over the last month. Fundamental guys are screaming that the cost of capital is now prohibitive to further growth. Technical guys are screaming that 25- year support levels were broken and now the floodgates are open to much higher rates. Somewhere a voice of reason needs to be heard.

You’ve come to the right place.

The fact is that interest rates have been trending higher since 2004, which coincided with the beginning of the rateincrease campaign started by former Federal Chairman Alan Greenspan. The increase, though, has been fairly gradual and orderly. In addition, some kind of increase was necessary, otherwise we would have slipped into a period of deflation and ended up looking like Japan: practically zero growth for 15 years.

But we avoided that fate and now there may be a new beast to worry about. Well, new in terms of the last 25 years.

A majority of the people who make investment decisions over a majority of the money in the markets lived through the nasty inflation-infected decade of the 1970s. The slightest indication of higher interest rates sends these experienced folks into an absolute terror. And they are right to have those fears; high inflation is a game changer. I just don’t think now is the time to pull out the worry beads.

For the last three years, I have consistently claimed that runaway inflation is not a near-term threat to our economy. There are two main reasons for my belief:

One is the persistently cheap production costs that exist in Asia. The advantage should manifest itself for years to come.

The second reason is an idea pronounced by the futurist Raymond Kurzeil of MIT. He says the powerful forces that created deflation in the technology industry are spreading to almost every other industry in the world. As technology becomes more integrated into everything we do, Moore’s Law will have an influence on more industries. This will serve to keep inflation somewhat in check.

But both factors also help lead to world growth-which leads to higher demand for oil and other commodities. Oil is not something that is easy to reproduce and it is the main driver behind the recent increase in interest rates. This time last year, oil reached $78 a barrel and the stock market and economy found a way to keep charging ahead. For now, I think that’s still the case.

The recent run-up in interest rates is not a reason to get defensive. I expect rates to cool off a little in the months ahead and equities to continue their run, for the intermediate term.

Eventually, something will come along and kill this bull market-probably higher interest rates and inflation. Perhaps that’s why financials and the interest-sensitive utilities are lagging the general market over the last few months. But it typically takes a while (many months) for higher costs to really get into the system.

Reacting today for a storm that comes next year might cost you some serious opportunity.