The credit crisis that occurred roughly between 2007 and 2009 caused a high amount of global financial market turmoil. Recently, fears that the global economy may head back into recession have surfaced and have started to reinforce a number of investment themes that have been in play over the past few years. Generally, this has consisted of uneven stock market returns, low interest rates and rising popularity for a select handful of assets. At some point, these themes could reverse course, which would make the below moves quite bad for your financial health. (To see what the effect this financial crisis will have, read 5 Long-Term Consequences Of The Recession.)
TUTORIAL: Credit Crisis
The stock market has been particularly volatile so far in 2011. The year got off to a good start and by May, major stock market indexes, such as the Dow Jones Industrial Average and S&P 500, reported total returns between 5% and 10%. But starting in August, gains for the year evaporated and these indexes are down between 5% and 10%.
The daily volatility has been just as bad, with market swings of several percentage points a normal occurrence right now. The volatility stokes fears that the global economy may be stalling from a recovery that has been taking place since the height of the credit crisis in early 2009. But selling when the market is pessimistic over the short term is usually a bad move. Stocks require an investment time horizon of at least five years, which is needed to ride out rough market stretches. It is also well documented that market timing doesn't work, so there is no use in trying to outsmart where the stock market may be in any given quarter, or year.
Sell Your Home
The credit crisis stemmed from what has arguably been the most severe housing bubble in history. Housing losses have been so bad in many markets, that an entire generation is becoming disenfranchised with owning a home. Paradoxically, many individuals felt the most comfortable buying homes when credit was easy and houses had experienced roughly a decade of double-digit annual appreciation.
That virtuous cycle has quickly turned into a vicious one. Many banks are requiring prohibitive down payments of 20% or more in the worst hit markets that include Las Vegas, Phoenix and parts of Florida. Home buying sentiment remains depressed, even though interest rates have hit rock bottom levels, as have home prices. Just recently, the interest rate for 30-year mortgages hit its lowest level on record of about 4.15%. Given the depressed environment, selling now looks unwise as housing prices look extremely affordable and will likely appreciate in value in the coming decade.
With many investments, including stocks and housing, out of favor and fears that the global economy is again slowing down, fewer asset classes are seeing gains these days. One class that is working is commodities, with precious metals in particular a popular investment. More specifically, gold prices have been skyrocketing and recently hit an all-time high of more than $1,900 per ounce.
Gold is seen as an inflation hedge and store of value in uncertain times. Perhaps it is its physical characteristic, as gold can be held and stored in a safe deposit box. However, over the longer term, it has made a lousy investment. On an inflation-adjusted basis, it is still trading below its 1980 peak of $2,400 per ounce. Overall, gold prices may run further, but an investment doesn't make sense when looking at its historical trading trends. (For more on gold, read The Gold Standard Revisited.)
Low mortgage rates and economic uncertainty are indicative of a low overall interest rate environment. To help spur the economy, the U.S. Federal Reserve has helped support a low interest rate environment while investors have rushed into government bonds, as they are seen as the closest to a risk-free investment that exists. This has pushed rates to historic lows. Ten-year U.S. Treasury rates recently fell below 2% for their lowest levels in more than 70 years.
As with housing, an extremely low interest rate environment makes the possibility that rates go up over time much more likely. In regard to bonds, higher rates make owning them a losing proposition. And higher inflation, fears of which are pushing investors into gold, would mean big potential losses for investors in longer-term bonds. If investors have no choice but to own bonds, shorter maturities would be better, but the best course of action would be to avoid bond investing as much as possible.
Buy the Yen
Currency investors have been piling into the Japanese yen, which has pushed up its value against many securities, including the U.S. dollar. A number of reasons have been cited for the yen's rise. In similar fashion to gold, it is one of the few assets that is appreciating in value these days, so it may be seeing continued momentum because it is simply rising in price. This is also known as trend-following and can persist for some time.
Others cite peculiarities of the Japanese market, such as a stable base of investors that keep their capital in Japan regardless of its rock-bottom interest rates. Reconstruction from a devastating earthquake, rains and tsunami have also been cited and could spur economic growth after a multi-decade lull, which makes investing in the yen more appealing. However, the rise of the yen could just as easily reverse course, especially if other asset classes start working.
The Bottom Line
Generally, an investment that appreciates significantly in value has the potential to see appreciation slow or even reverse course. By this same logic, an asset class that has struggled, or is seen as unpopular, can have solid upside potential on the view that it could become more popular. Overall, individual financial moves must be based on fundamentals, so if the global economy remains on uneven footing, the trends cited above could continue indefinitely. (To help you make sound investing choices, read 5 "New" Rules For Safe Investing.)
Disclosure: At the time of writing Ryan C. Fuhrmann did not own shares of any company mentioned in this article.
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