This expansion has entered the record books as the longest ever. Consequently, you hear it referred to as “late-cycle.” But expansions “don’t go through youth, middle age and then inevitably croak,” says Timothy Taylor, of the Journal of Economic Perspectives. When they croak, it’s for a reason. Something comes along and shoots them down.
There’s a whiff of powder in the air. Growth and consumption are roaring, workers are in short supply and the global expansion is putting pressure on commodity prices–all worrisome things, says economist Barry Bosworth of the Brookings Institution in Washington, D.C. Price inflation ran at 2.7 percent last year, up from 1.6 percent in 1998–still low, but not a confidence builder.
Enter the Federal Reserve, which is raising interest rates to slow down growth. As I hope you learned in Investing 101, the Fed always gets its way. A quieter economy should mean no worse than a correction for stocks. But rate changes aren’t perfectly predictable. It’s possible that, over time, they hit business too hard.
So far, the Fed has shown preternatural wisdom (or had preternatural luck). It has steered the economy through several crises, from the ‘87 crash to a spate of international currency crises.
The extent of fiscal discipline has been remarkable, too. Thanks in part to gridlock between Congress and the White House, neither tax cuts nor spending cuts went too far. For the past two years the government has used its raging budget surplus to reduce the national debt. Big tax cuts are fine during periods of faltering growth, because they add to demand. But debt reduction provides more capital for investment, RFA’s Zandi says.
Good luck and good management have left investors feeling pretty safe about stocks. But although stocks in general do better than bonds or cash, that’s not true of each individual stock. Some of the lovelies that rose to record prices last month will not even exist in a couple of years.
Here are some things to think about:
High techs and dot-coms: Are they a bubble? “You bet they are,” says economist John Makin of the American Enterprise Institute in Washington, D.C. The question is whether the Fed can prick it without spreading even more carnage around.
Cash and bonds. If you moved some money out of stocks, you’re probably glad you did. If not, and you’re playing with money you’ll need within a couple of years, take it off the table now. A good scare is always better than good advice, for those who invest beyond their means.
Stocks and stock-owning mutual funds. Long-term or aggressive investors are prospecting for opportunities. Some love beaten-down stocks, such as real-estate investment trusts. There’s also a lot of interest in international and emerging-market funds. “Those countries are copying America’s miracle, by working toward New Economies of their own,” says Allen Sinai, chief global economist for Primark Decision Economics in New York. He’s high on global growth stocks, too.
Taylor’s long-term favorite remains the U.S. market as a whole. He buys it through total-market index funds, such as those at Vanguard and Charles Schwab, which follow the Wilshire 5000 index of both larger and smaller stocks.
Personal debt. Once pressure starts being put on the economy, no one can predict how far things will go. You shouldn’t have debt that will bite you, if interest rates rise by 1 or 1.5 percent, Sinai says.
The Fed is especially worried about two things. First, the surge in “subprime” credit for people already heavily in debt (nearly 13 percent of households, by its latest count). Second, the surge in margin–money borrowed from brokers to buy stock. Margin debt shot up 25 percent from October to December last year.
John Makin, for one, smells flowers and thinks there’s a coffin, for sure. “Golden ages end badly,” he says. Stock or real-estate bubbles–or both–create so much wealth that demand outruns supply. The Fed has to raise rates faster than expected, and there’s no place to hide. Business growth stagnates or reverses, personal and investment spending drop and markets dive worldwide.
That’s a minority view, right now, “but it doesn’t pay to get too cocky,” Taylor says. I’ve said it before: spread your risks around.
