Asset classes don’t go bankrupt, but neither do they consistently radiate value relative to the competition. Indeed, the value of any asset class waxes and wanes, providing an endless stream of opportunity and risk.
Deciding if one or the other dominates in one or more asset classes is the perennial challenge, a task that itself goes through its own peculiar cycles. Sometimes there are screaming buys, and sometimes valuations are at pinnacles of excess. Unfortunately, such extremes are rare. Most of the time, valuations are a gray area, making analysis uncomfortable and prone to error due to the whims of the moment. That, one could argue, describes the current climate for the major asset classes, where neither bargain nor excesses dominate.
The immediate source of this middling scenario is the fact that ours is a time of transition in the price of money. Interest rates, in other words, are climbing. The latest evidence comes from the world’s second-most populous country. The Reserve Bank of India (RBI) today raised its key short-term rate by 25 basis points to 6.0%–the highest in four years. The hike was billed as a pre-emptive attack on inflation’s gathering momentum on the subcontinent, subtle though it may still be at the moment. The source for the monetary anxiety remains the bull market in energy, explained RBI Governor Y.V. Reddy. “Fuel prices, which account for 35% of the increase in wholesale price index, constitute a major risk to headline inflation,” he said, as reported by India eNews.
India’s hardly alone in raising the price of money or worrying about the future for inflation. Central banks the world over are generally tightening the monetary strings, albeit after a lengthy period of easy money. Because rates around the world have been so low in real (inflation-adjusted) and absolute terms in recent years, the reaction by the capital markets has been sluggish compared with previous rounds of tightening. Indeed, the frog doesn’t jump out of the pot if the transition from cool to boiling water is slow. But at some point the frog realizes that he’s being cooked alive, at which point it may be too late to snatch victory from the jaws of defeat.
Something similar may be unfolding in the world’s capital markets, where optimism fueled by cheap money has helped investors see bull markets as the continued path of least resistance. The Federal Reserve has been more than a little complicit in this lethargic attitude adjustment, courtesy of its consistent delivery of “baby step” rate hikes over the past two years. But baby steps add up to something bigger eventually.