Have you ever looked back on a turning point in the market and thought “ah that was logical. If only we thought of that at the time”?
In fact you could probably look back on almost all turning points and say the same thing.
I agree with the view that markets frequently move from efficiency to inefficiency on both a small and large scale. Turning points in the market can often be the realisation that the previous valuation was wrong and the reversal is an attempt to get back to fair value.
No, I am not going all academic on you. There will be no talk of efficiency frontiers here. All you need is a little bit of logic. Take for instance US bond rates. The government (risk free) rate is about 3.5%. BBB rated corporate are only 5.5%.
US inflation is low and unemployment just hit the highest level in 26 years. This is why interest rates are low, but hands up anyone that thinks inflation and unemployment will remain the same for the next decade?
If you think about it, there is no way you can come out ahead by buying a government bond paying 3.5% and holding it until maturity. You’ll earn 3.5% on your money and of course pay tax on that. After tax, is that rate of return going to beat inflation over the next 10 years? Highly unlikely.
This is where logic can play a part. At some point bond prices will turn south. It will most likely need a few economic figures to trigger it – perhaps retail sales or business confidence – but it will happen. The really interesting thing is that it will take other markets with it.
Think about it. Lower US interest rates compared with those overseas has hit the US Dollar. Have a look at the Aussie Dollar for example. Australian rates are also low, but not as low at the US. It’s the interest rate differential and the timing of recent rate moves and expected rate moves that has pushed this one from about 0.6200 to about 0.9200 in 2009.
The lower US Dollar has in turn pushed commodity prices higher. Commodities such as Gold and Oil have got cheaper in non-US Dollars as the US Dollar fell. As such, this created buying pressure and those markets push higher.
At some point the market will realise that 3.5% for a bond is a good shorting opportunity. That will in turn bid up the US Dollar and that will trigger some liquidation in dollar denominated commodities. It could well be a big move.
