INVESTING: Keep eye on inflation but don’t batten down hatches

For the first time in a while, I am going to use both hands when I write the column. If you visit this space even occasionally, you know I call my spots and I don’t hedge my opinion. I was practically all alone in late February when I wrote as forcefully as I could to buy in the sell-off, which was almost the exact bottom, and readers have been amply rewarded.

But today I am going to talk about interest rates and inflation, and there are going to be at least a few “on the one hands” and a few “on the other hands.”

The Federal Reserve concluded a few weeks ago that there was no need to change interest rates. The market took off because the slight bias toward more increases disappeared, giving inflation worrywarts a little breathing room. A lot of big money has been concerned with rising inflation and with thoughts that the commodity price spike of the last couple of years was going to spill dangerously into the rest of the economy. The Federal Reserve last increased rates in June 2006, and fears have been slowly dissipating since.

That big money I referred to is people who lived through the nasty, raging interest-rate environments of the 1970s. Stocks got hammered, bond prices got blitzed, and commodities went wild to the upside. The last few years have a few too many reminders for these experienced holders of wealth, and they have been unduly afraid of a return. I think we all understand why inflation is a beast, but if we are taking more than precautionary steps for an event that doesn’t happen, we are severely underusing our assets.

I said this past December that interest rates in 2007 would trade in a range, with the yield on the 10-year moving between 4.0 percent and 4.5 percent. So far, that’s been the case, and with nine months left I would only widen that predicted range by a few basis points.

On a longer-term basis, I’ve been saying for years that inflation does not have a good chance of kicking up a big storm due to technology and globalization. The same rule that causes deflation in technology is spreading to almost every other part of the economy. It’s not quite as drastic as Moore’s Law, but the concept is the same.

Globalization is becoming the primary driver behind the inflationary lid, and it is taking on some interesting forms. Recently, the Singaporean government lowered its taxes to be more competitive with Hong Kong. The Hong Kong government answered immediately with a tax cut. Let’s hope this behavior spreads throughout the world, as it is seriously anti-inflationary. Around the same time, India radically cut a series of tariffs, with the Indian government saying it hopes the move helps contain inflation. Oh, it will. Again, here’s my hope that other governments follow India’s lead on this.

If interest rates are in a mood to run up, the stock market is no place you want to be. But why walk around Phoenix in the spring wearing a raincoat and carrying an umbrella? The stock market throws a lot of different weather patterns at us. The longterm secret to investing success is to wear the right gear for the current conditions.