We have now reached a milestone – the Dow Jones Industrial Average has reached 13,000, and prosperity continues. But economic indicators are mixed, and eventually the economy will slide into recession.
Here’s how future economic developments may affect you.
Q: If we have a recession, does it mean the stock market boom is over for good?
A: Recessions are a natural part of the economic cycle, just as winter is part of the seasons. Recession happens because interest rates and inflation rise, so consumers slow their spending, and production slows. But cheer up – economic growth cycles are much longer than periods of recession, so even if recession hits, recover is just around the corner.
Q: It is likely that a recession will happen in 2007 or 2008?
A: If you were running for president, would you want to do so in a strong economy or a recessionary one? So election years are rarely big years for recessions. But consider this: If there were a recession during your term as president, would you want it when you were running for re-election, or years earlier? For that reason, if the new president in January 2009 sees recession on the horizon, he or she might let things slide and get it out of the way early in the administration. (But whether the president has much power over recession is a subject of great debate.)
Q: Will I get a better interest rate if I buy a ten year bond than if I buy a three year bond?
A: That is usually true, but right now we have a very flat interest rate curve, and we might end up with inverted interest rates. That means you are better off buying bonds in the shorter end of the yield curve.
Q: Is the bull stock market is coming to an end?
A: Yes, but when is the question. All bull markets eventually end, and here are some of the clues that a bull market is ending:
- Interest rates rise for 3-month Treasury bills
- The Federal Reserve raises the discount rate three times.
- The Department of Commerce’s index of leading economic indicators is down three months in a row.
- The stock market indexes are moving up, but the advance/decline line (the difference between the winners and losers each day) is dropping
- One stock market index is moving up, but others are declining.
- We have had some of these over the past year, but not all of them together. Stay tuned.
Q: When the bull market ends will it be like the stock market crash of 1987?
A: Stock market speculation and program trading have been severely collared by federal regulations since the stock market crash, and now complex trading brakes kick in to cushion the fall when the stock market begins to slide. An economic crisis likely will creep rather than crash.
Q: Do mortgage rates go up right after the Federal Reserve raises interest rates?
A: Certainly rising federal funds rates (the interest rate that banks charge each other) impacts interest rates, but the impact is anticipatory. That is, interest rates go up in anticipation of the rise, not in reaction to the increase. So it’s already built into your mortgage rate. The real question is, what’s around the corner?
Q: If recession looms, is my best bet is to convert everything I own to cash and wait out the storm.
A: Hunkering down is a good idea when a tornado is approaching, but it’s bad advice for a long-term investor. If you sell, you may miss the party later. The total gain from a bull market tends to occur rapidly at the beginning of a market recovery. So it’s more important to be in the bull market from the beginning than it is to avoid the bear markets.
Q: So it sounds like in any market, even volatile ones, a savvy investor can make money?
A: Very, very true. Volatility can actually help you if you are a regular investor. For example, let’s say you have $500 going into a stock fund in your 401(k) each month. If the market is down on payday, shout “Hooray!” That’s because you’ll get more shares for your money than if the market were up. It’s like going shopping and finding that everything you need is on sale.