Can We Learn from History?

In the summer of 1982 Henry Kaufman, the legendary Dr Doom announced that interest rates had peaked.  I was a summer associate working at a law firm, but I remember that the stock market instantly skyrocketed.  Interest rates had peaked, inflation was licked, and it was smooth sailing ahead.

Essentially, my entire career (and the careers of an entire generation of investment professionals) has been spent in a falling interest rate environment.  From 1981 through 2012, the yield on the Treasury Bond has fallen from just below 16% to below 1.5%.

This decline in interest rates corresponds with an explosion in stock prices, both here in the US and globally; in developed markets and developing markets a like.  Furthermore, this same period is also reflects a benign inflationary period in the U.S.

I’m not stating anything new or earth shattering.  However, I do wonder about the effects of this generational experience upon the professional investment industry.  There are few advisors or managers out there who successfully managed assets in a steadily increasing rate environment or during periods of rapidly increasing inflation.

Are rates rising?  What about inflation? Who knows?  And, I certainly do not even begin to posses the skills to analyze these issues.

However, I can look at a simple graph and see trends … or the lack of trends…. and it flies in the face of reason to think that low interest rates and low inflation will continue forever. Therefore, if nothing else, fiduciaries should begin thinking maybe even worrying about inflation and an eventual upturn in interest rates.

While I would never shill on behalf of one manager over another, I nonetheless attended a very impressive presentation by a highly regarded investment management firm in which they laid out their case for the building inflationary pressures and their proposed solutions for this potentially new environment.

Historically, certain asset classes perform well in an inflationary environment: inflation linked bonds, currencies, gold, commodities, real estate. While they are not suggesting a dramatic shift to these asset classes, they nonetheless do recommend gradually incorporating exposure to these assets.

Fiduciaries should evaluate these proposals.  If they choose, they should also feel free to reject them in favor of other perspectives or strategies.  The real issue is that Fiduciaries should not simply rely on the “same ol’, same ol’” practices.  To do so, would be imprudent.

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