A Hand On The Pulse Of U.S. Economy

If you want to have a hand on the daily pulse of the U.S. economy, you should start getting into the habit of reading the daily "Credit Markets" column published in The Wall Street Journal.


The Journal rotates reporters for this column. It seems to be a training ground and a must-have skill for Journal reporters to know something about the credit markets, interest rates, government policy, inflation, unemployment and asset pricing.

To understand this column, you need to know something about how treasuries, interest rates and fixed-income securities are related to each other. The column tells you quite a bit about where capital felt like being during the previous day and where it expects (i.e. expects today) to be in the future. It also tells you something about the expectations regarding Federal Reserve plans to interfere in interest rates, which are set by offering government bonds of various duration.

Once you're capable of reading and parsing this short daily column in the Journal, you'll probably know enough macroeconomics to last you a life time.

One golden rule, which keeps repeated, almost daily, in every edition of the column, is the following: The price of bonds and their yield move in opposite directions. When the price of bonds go up, their yield goes down.

So, for example, if the Treasury wants to reduce interest rates, it will constrain the offer of treasury bonds in order to keep their prices high. If it wants higher interest rates, it will pump more treasuries into the market. On the other hand, the Treasury may have yield power in the course of events. It might have to borrow for the government, which will reduce treasury prices and increase bond yields and interest rates.

For the daily investor, the catch is the duration of bonds. How long does it take for a bond to reach maturity and how is the coupon payout distributed during that time? This question will determine whether the bond holder has locked himself correctly onto an interest rate profile that provides him with the best return against interest rate fluctuations. Of course, while the mathematics of fixed income securities is quite elegant, there are unpredictable causes such as huge government borrowing, the real estate defaults and other factors that always make a good prediction somewhat suspect, giving rise, effectively, to a certain amount of betting (or gambling) on interest rate options even if the investor is not actually buying or selling these options explicitly, and herein lies the cause to speculative fervor in an interest-rate based economy, from which there is very little scape as long as "capital" proves itself to be scarce or as long as there are no alterative institutional models in sight for its efficient (and effective) assignment and distribution.

Comments:

Masood, Here is another area that you and I have an overlap -- an interest in the stock market. Since I have retired, I spend a lot of time in the morning reading the WSJ -- at least 2-3 cups of coffee time wise. If you are so inclined, can you tell me about your investing style. I essentially buy dividend and growth oriented stocks. I don't get rich quickly, but they normally get better with age. Some I buy through a broker and keep in an Edward Jones account. However, many are DRIPS so I save a lot on fees. When I retired, the question was: do I want to keep trying to stay up in my area of research, or what? Since I was now living on a fixed income, and I had been dabbling in this for years, I decided this would be a good and new area to try to master. It has keep me very busy. BTW -- one of my favorites reads is "Fooled by Randomness" by Nassim Nicholas Taleb. I suspect you have read this. Best, Ralph

Posted by Ralph Hannon on September 23, 2005 at 10:46 AM PDT #

Ralph,

I'm afraid I do not provide and have no license to provide investment advice. I'd say Warren Buffett probably has some good ideas. I would recommend his essays along with Benjamin Graham's Intelligent Investor. Different people choose different styles. It's important to stick to a successfull style and see how far you can get with it.

Have fun,

Masood.

Posted by M. Mortazavi on September 26, 2005 at 04:05 AM PDT #

Masood, Actually, I was not asking for any advice, but rather if you had an investing style. I just know that from your past post, you have a pretty good working knowledge of the economy. I enjoy reading what other people are doing -- especially those who know what they are talking about. Morningstar has an excellent diversity of chat groups for this. Ralph

Posted by ralphhh on September 27, 2005 at 11:35 AM PDT #

A couple of years ago at Haas School of Business, I took a course on investment strategies and styles with Robert O'Donnell, who is himself a managering partner on a mutual fund and sits on the UC Berkeley's foundation board of trustees. What I know about investment styles comes from that and my own approach was affected by what he said and the reading material.

First, even before I took the course, I knew something was fishy about the CAPM (Capital Asset Pricing Model) because it assumed that equity markets (e.g. stock markets, etc.) were "perfect" in the sense that they captured (in prices) all the information and signals which can determine the value of an asset. This is a rather circular perspective. It doesn't explain why some make money while others lose them in the market. It also advocates the large index approach to investment. Well, all I can say is that the readings in Robert O'Donnell's class, including those on behavioral economics (say Richard Thaler's Winner's Curse: Paradoxes in Economic Life disillusioned me. There were others who wrote more hopefully. George Soros' contrarian style of investment and Benjamin's Graham's motto (markets vote on stocks while intelligent investor weight them) affected me. O'Donnell also showed that the optimal investment profile is probably a dozen styles or less.

In my own private investment, I cleaned up the number of stocks I held. I got out of investment that mimicked too closely my own stock options in the company I work for and tried to diversify by holding a small number of stocks in industries I knew something about, say the telecom industry. I bought into telecom in 2001 and 2002 and made out very well in 2004. (Mutual funds analysts that came through Haas in 2001-2002 academic year were down on telecom stocks but I paid no attention to what they had to say. They seemed to be too narrow and too bound up with their own world to understand the larger movement of prices.) I've narrowed this down continuously, partly because life expenses have kept me away from large number of stocks and partly because I found one or two which had good pay off and never lost value. I stock to those. Surprisingly, one of them is a very attractive dividend paying stock, like the ones you use. In investing, I also try to be awar of macro-economic trends and stay away from quick turn-around speculation although it looks like doing a bit of the latter may also be useful.

Posted by M. Mortazavi on September 27, 2005 at 04:57 PM PDT #

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