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The question is being discussed broadly across blogoland and investors: can stocks rise, in a rising interest environment?

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The answer is clearly no.

However, the argument will be; yes, but that was an extraordinary time, inflation was rampant and Volcker had to push interest rates higher to tame inflation. There is no inflation to speak of currently.

Really?

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There is plenty of inflation. There always has been ever since the US went off of gold and the dollar became fully fiat. To fund any shortfall in government spending, the US simply borrowed. Very often the Federal Reserve was that purchaser.

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The result being that the money supply has increased, which is responsible for the price inflation.

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So the bottom line is this. Stocks will rise with inflation in nominal terms. Sometimes they will rise in real terms as well. Stocks are [reasonable] inflation hedges when interest rates are not rising to combat inflation, which, is pretty much never if the government have their way.

The question should really be: how bad does inflation have to get before the only answer is to let rates rise, or force them to rise?

The constant rhetoric out of the Federal Reserve is that inflation is low to non-existent. The pledge is to keep interest rates low possibly into 2016.

Inflation will remain manageable [in Fed terms] while the economy is depressed and unemployment high. Why? Because as prices rise, consumers who cannot afford, do not purchase, thus reducing demand. This reduced demand has till now resulted in a compounding inflation rate of around 2.3%. If by some miracle employment levels rise and the economy starts growing and credit expands, that 2.3% will jump.

At that point what does the Fed do? Do they allow inflation to continue higher? Or, do they try to nip it in the bud, and if so, what happens to the economy on the ‘initial rise’ in rates?

The cycles are long runs. The current highs are defined from [more or less] the highs in 2000. I know we have broken higher technically, and while rates remain low and inflation chugs merrily along, it is practical to stay long, selling down periodically to lock in profits…trading the market rather than just B&H, which, could result in losing profits gained if we get for whatever reason a market break.

The takeaway – markets do not rise into rising rates. They may not fall, but, they do not move significantly higher in nominal terms. In real terms they might even gain a little, but it isn’t flash.

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