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Saying that -- from 1940-1952; real interest rates were volatile but also predominantly negative with the highest peak at 5% in 1949. The median monthly rate from 1940-1952 was a negative .92% and the average rate was a negative -2.84%.

As everyone expects interest rates to rise -- history suggests something else is likely to happen.


Thanks to MrTompkins for bringing up interest rates and specifically the 1940s.

Focusing on "real" interest rates, that is after inflation is accounted for, maybe of academic interest. But, how relevant is it to the big picture?

looking at the 'forties is of some interest because there are significant similarities with today's financial and economic realities. Is what happened then a harbinger of things to come? Perhaps.

Generally, when there's a large federal deficit, as there is now and was then during the mid-to-late 'forties, inflation tends to spike up. The late 'forties was no exception. Peoples' spending power eroded because of a relatively short period of aggressive inflation and there was no comfort to be had because of low interest rates. Like today, in the 'forties, the Fed engaged in a massive bond buying binge. As a consequence, the stock market rose aggressively (sound familiar?)

It was perhaps the inflation of '46 – '48 that, ironically, came to the government's rescue, in as much as it prompted President Truman to sign anti-inflation legislation. This led to a recession and even a touch of deflation. Recessions lead to a higher demand for Treasuries (a flight to safety). This particular recession gave the government a chance to unload a lot of their bonds. This didn't ameliorate the recession, but it did provide a period for them to unwind when there was, at least, a renewed demand for bonds. Trying to unwind when there's a low demand for bonds isn't a good scenario.

What happened to a stock market that had more than doubled in the previous four years? From its peek in 1946 to a bottom, four years later, it was down 24%.

So, what is in our future? Hard to say of course, but our recent past, in several ways, is similar to the 'forties. Almost always large federal deficits lead to inflation. Unless this time is different we will see some. The Fed has to unwind at some point and the process is likely to be painful, whether they get the opportunity to do so come a new recession, or are forced to do so against the wind, in an environment where the demand for Treasuries is scant.

For stock investors, given the massive run up in the market since the spring of '09—eerily similar to the run up of '42 to '46—a 24% decline shouldn't be a total disaster and would, not doubt, provide buying opportunities as it did then.

Weighing what happened during the 'forties, and the similarities with today, as one decision-making factor, I won't be running away from stocks, but rather fastening my seat belt. As it proved to be back then, staying in stocks is perhaps the best option today. That is, unless you consider yourself a brilliant market timer. Some people get lucky and pull out and get back in at the right times. Most don't.

Time will tell…

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