Nowhere do hearts leap higher at the sight of newly elected Republicans than on Wall Street.
As midterm-election results rolled in last month, bond traders set aside the crash helmets they’ve been forced to wear this year.
The stock market, in desperate need of direction, lunged at the positive news. The enfeebled dollar strengthened.
A few brave souls talked about a “sea change” in the nation’s economic agenda.
But within 24 hours, the heroic attempt at euphoria melted as investors faced banal reality: In the short run the Republican sweep probably won’t make a lick of difference.
And the long run?
Pick your pundit.
“It’s potentially positive for the bond market,” says Bill Gross, managing director of PIMCO.
“The bond market will continue to go down,” predicts Hugh Johnson, chief investment strategist of First Albany.
“The electorate might get what it wants, but what it wants may not be good for the markets,” says David Shulman of Salomon Brothers.
Gee, thanks, guys.
Ordinary investors already have enough to be confused about.
Despite the sunniest set of economic conditions we’ve seen in years, the bond market has been crashing since October 1993.
Corporations are pumping out spectacular earnings, but the stock market has sullenly refused to budge from where it stood on Jan. 1.
If even a Republican rout doesn’t excite the markets, is it time to throw in the towel? Here’s the outlook:
– Stocks. Something is wrong with a market that turns up its nose at “Contract With America,” a Newt Gingrich-designed bouquet of promises that couldn’t smell sweeter.
The trouble: Wall Street fears tax-cut fervor could produce larger budget deficits-the height of fiscal impropriety in a strong economy-which would damage stocks and bonds.
A Republican Congress could certainly generate some good economic results, but the question is when.
It wasn’t until two years after Ronald Reagan was elected in 1980 that stocks lifted off.
For now the current bull market is staring at the same boring problems it has faced all year: its old age and its increasing unattractiveness compared with the bond market.
Stocks are yielding only 2.8 percent on average, whereas a five-year Treasury note pays 7.7 percent. And there are other signs of a peaking market. Inflation fears are mounting, and the Federal Reserve Board is expected to raise interest rates.
The stocks that have stepped lively this year are the ones that typically perform best at the end of a bull market: chemicals, paper, metals and other industrial materials producers.
– Advice. For investors determined to stay in the U.S. stock market, those are the groups to stick with. Robust growth in 1995 will keep factories and plants humming and demand for raw materials high.
Also look at technology and heavy machinery, two other industries that should excel amid strong global growth. Because of inflation fears and increased demand, gold stocks also look poised for gains.
The safest course, though, is to pare your exposure to stocks and put the money in bonds or cash.
“Stocks are expensive, and bonds are pretty darn cheap,” says Brad Tank, a portfolio manager at Strong Funds.
– Bonds. When onetime Clinton strategist James Carville said last year that in his next life he wanted to come back as the bond market, he was joking about its power to intimidate the Clinton administration.
Little did he know: making presidents quake was just the beginning. Over the last 12 months, the market’s decline has pummeled Wall Street firms, roiled foreign markets and shriveled retirement savings.
The price of a 30-year Treasury bought in October 1993 has fallen by 25 percent. “This has been the worst bond market in history,” says Joe Deane at Smith Barney Shearson.
Is the bloodbath over? A lot of pros are counting on it. The bulls love Washington’s tough talk on defending the dollar, signs that inflation remains tame and, most important, clues that the Federal Reserve Board will raise interest rates again.
If the economy can be brought to heel by the Fed, they say, bonds could stage an enormous rally.
It may not be that simple. Why? First, bond prices are still inflated by speculators who borrowed money to invest in it. As they pay off their loans, or exit the market, there’ll be less money to keep bond prices aloft.
More important, though, is bond traders’ inability to get a grip on reality. They’ve repeatedly underestimated the economy’s strength, which hurts bond prices because it portends higher inflation and interest rates.
– Advice. There are several strategies for coping with bottoming bond prices. One is selling your bonds to reduce your taxes.
Losses are applied against capital gains on your income-tax return, thereby avoiding or reducing capital-gains taxes. (If you have stocks that have risen, this may be the time to match your stock gains to losses from bonds.)
Excess losses of up to $3,000 can be used to reduce ordinary income on your return. If you believe the bond market will revive soon, you can take a second step: Immediately buy bonds that are similar to the ones you just sold. This is a “bond swap.”
To count as a tax-advantaged swap with the IRS, two out of three key features of the new bonds must differ from the ones you sold: the coupon, which is the rate of interest; the maturity, which is when the bonds will be paid off by the issuer; and the description, which refers to the issuer.
Swaps work with bond funds, too. But why let a fund manager make your interest rate bets? Be conservative: Buy two-year Treasuries, which are notes issued by the U.S. government and available directly from your regional Federal Reserve Bank.
Then gradually buy longer-term issues over the next 12 to 18 months. The safest choices while the markets sort themselves out are short-term certificates of deposit or money-market funds. It may not sound sophisticated, but it’s the strategy that won 1994’s investment derby, hands down.
