by Archie M. Richards, Jr., CFP^®
May 10, 2004

When most investors crowd the trail in one direction, take a hike the other way. Investors are now selling stocks primarily because they're worried about inflation and rising interest rates. Since investor sentiments are usually wrong, you should expect little or no inflation and inconsequential rate increases. Look for stock prices to rise.

Here are signs of inflation concerns:

• The recent strong desire for Inflation-Protected Securities (TIPS). TIPS are IOUs from the U.S. Treasury whose maturity values and interest payments are regularly adjusted for inflation. Investors have been buying these bonds by the bushel. A newly-issued TIP has a lower interest rate than a regular Treasury of the same maturity. But if inflation returns, TIPS will end up more profitable. If inflation does not return, TIPS will be the worse choice.

• The majority of investors are usually wrong about major economic trends. Treat their interest in TIPS as evidence that the inflation issue will be bogus.

• Advertisements also reveal inflation fears. No one knows better what people think than advertisers. When they're wrong, their ads have no impact and the huge amounts of money they spend are wasted.

During the boom market of 1999, when people were bullish, the ads of financial institutions featured investment growth. As the market plummeted and people were bearish, the ads featured safety. Now, the only advertisements I find that contain an investment bias are the ones that promote the purchase of gold.

Bingo. Advertisers are taking advantage of the public's fear that inflation will become a problem. Investor sentiments are usually wrong. Expect inflation to remain insignificant.

Don't be concerned, either, about last year's increases in commodity prices. The price of nickel, for example, rose from $7,210 in January 2003 to $17,770 per ton a year later. Many investors believe that such increases will quicken future inflation. But they're unaware that some of the price trends have reversed. In the first four months of 2004, nickel has fallen from $17,770 to only $11,155 per ton. Why? Because new mines are coming on stream, increasing the supply.

That's the key: Higher commodity prices evoke new production, which drive prices down.

Oh yes, oil prices are hitting new highs. But they won't stay there. The world isn't running out of oil, far from it. It takes time for oil companies to gear up production, but gear up they will.

The recent commodity price increases will not inflate final consumer prices. Commodity costs have little impact on consumer prices. The increases are outweighed by improvements in productivity. By far the largest portion of final consumer prices are labor costs, and these are being suppressed everywhere by labor-saving technologies.

Investors are not just worried about fears of inflation. They also fear higher interest rates. During periods of rapid growth, such as we're experiencing now, short-term rates usually rise. But the increases this time won't be significant. They won't last longer than a year or two. And they won't suppress the growth of the economy or increases in stock prices. In the long run, interest rates will resume declining. They've been going down for 24 years, and they will continue doing so.

Some final comments about matters that concern investors:

• Messy though it may be, the war against terror is succeeding. Not counting the attacks on troops in Iraq and Afghanistan, the number of international terrorist attacks in 2003 fell to 190, the lowest number since records began being kept in 1982. The war isn't won yet, but we're getting there. A few more years and the terrorism problem will be licked.

• Don't be troubled about the outsourcing of labor to other countries. Toyota employs 19,000 people in the United States. This is big-time insourcing. If the government suppressed the outsourcing of jobs from America, foreign-owned companies would lay off thousands of American workers. The outsourcing issue will blow over. The more the world economies are intertwined, the better for everyone.

• The world's most important economic trend is rapid technological advance. Productivity will continue to improve, producing a flood of goods and services. Increases in production will outpace increases in the money supply. Eventually, consumer prices will go down.

Buy stocks. They're going up.