Faith. That's what is needed for investors to buy stocks and bonds today. Investment analysts maintain that if you have faith in the intention and ability of the Federal Reserve System to maintain its anti-inflationary policy, then it is logical to expect prices of bonds especially, and probably of stocks also, to rise.
Contrariwise, if you expect the Fed to ease its tight money policy, then sell for cash.
H. Erich Heinemann, an economist with the investment banking firm of Morgan Stanley & Co., says, "It is a good time to be a coward."
He says, "The issue is not whether the Fed is going to ease, but whether the Fed has eased too much." His personal view is that the Fed, through a rapid expansion of the so-called "monetary base" since July, has temporarily lost control of a needed monetary expansion. As a result, investors are expecting inflation to rise and the Fed to have to tighten up later. That means higher interest rates and falling bond prices.
Mr. Heinemann says he has bailed out of the corporate bond and stock markets "to let the dust settle."
A contrary view is held by Frank Mastrapasqua, an economist with the brokerage house of Smith Barney, Harris Upham & Co. He has faith in the Fed's stern monetary plans. So he says 1981 will be regarded as "a major transition year for the bond market" -- an opportunity to lock in extremely good returns.
"At current interest rate levels," he says, "the total return achievable within the bond market is worth the risk." Even if today is not quite the bottom for bond prices, the investor can double his money within five years with today's interest rates.
As for stocks, Mr. Mastrapasqua suggests some caution because prices are now reflecting the slowdown in the economy and poorer corporate earnings. But he expects stock prices to be higher within 12 months.
In the meantime, Mastrapasqua is telling clients that utility stocks are "very attractive" as a defensive investment. Utilities are winding down their investment programs, getting rate relief, and finding their return on equity going up.
Many Wall Street analysts are blaming the downturn in bond and stock prices this week on the prospects for an enlarged federal deficit and continued high interest rates. But economists find no correlation between interest rates and federal deficits.
Whatever, interest rates have remained suspended high in the air, like a magician's helper in levitation, with no visible support. Most analysts would expect interest rates to drop with an economic slowdown.
However, economists are now spotting the props for today's record interest levels.
One such prop, reckons Allan H. Meltzer, professor of economics and social science at Carnegie-Mellon University, is public skepticism. "There is a lot of evidence around that people do not believe that inflation is coming down permanently," he says. If inflation is actually dropping, then lower interest rates would be more justified.
For example, he notes, futures prices for commodities such as gold, silver, lumber, copper, and so on indicate that investors expect the rate of inflation to go back up after its current decline.
Moreover, adds Dr. Meltzer, there is a widespread disbelief in the administration's budget and economic forecasts. "People do not expect the administration and the Federal Reserve to persist in their anti-inflationary policies." They have not done so in the past seven recessions, he maintains.
Another prop for today's high rates is the tough economic policies around the world. "What we are getting is not only a US disinflation but a world disinflation," says Meltzer. Japan, West Germany, Switzerland, Italy, and Britain (off and on) have strict monetary policies to protect their currencies from the attraction of the high-interest-rate dollar and to keep inflation down. France has just switched to an expansionary policy under its new Socialist government.
Smith Barney's Mastrapasqua sees another interest rate prop in the strong corporate demand for funds. But will the props hold much longer? You've got to have no faith to believe they will.