What's an investor to do in the treacherous market environment we are currently experiencing? Uncertainties abound, and that adds all the more to the confusion on the part of participants and results in a lack of conviction as to market direction.
In spite of this, the bond markets moved forward last week. Long bonds of all sectors showed impressive gains and more economists predicted that interest rates had peaked or were just about to peak.
But wait a minute? What happened to all the gloom and doom talk of a week or two ago? Why had the market rallied, especially with so little retail participation? Can a Reagan administration make that much difference -- several weeks before inauguration? Is the economy about to have a relapse? Are the monetary aggregates being brought under control? Is inflation about to be curtailed?
Answering these pertinent questions is about as treacherous as investing in the market itself. But some light can be shed on them.
As to the rally, most participants expected that the Federal Reserve would raise the discount rate after the election, which the Fed did late Friday. The short markets especially adjusted to the expected change.
The government bond dealers had just underwritten most of the $8 billion refunding that was sold after the election. The issues were poorly placed and the dealers had hedged their positions in the futures market.
When profits presented themselves in the futures market dealers took their profits and were left only with the issues they had purhased in the auction.
Since the discount rate had not been raised, the short-credit markets adjusted back to lower yields. Therefore with the futures market rising and short rates declining, prices began to improve in the cash market and a technical rally was under way. But still, little retail buying occurred.
Yes, the economy looks as if it is slowing down. But the monetary aggregate situation is about to become clouded because the new Monetary Control Act went into effect on the 13th. Many new financial institutions are now required to report reserve positions to the Fed.
The Reagan administration is still talking about a tax cut. But even when a tax cut occurs, it should be accompanied by a cut in government spending.
So what should an investor do? With new funds, one-to five-year investments would be wise. There is a stream of short-term tax exempt notes in the one-to-three-year area that will return 7.5 to 8.2 percent.
For investors who hold long bonds and have profits in other investments, take year tax looses now and stay in long bonds. However, if and when a rally comes, be prepared to sell these long bonds and move into much shorter and safer maturities.