Understanding The Real Rate of Return!
There is one indicator more than any other which determines the health of an economy and it is the Real Rate of Return.Furthermore this is the simplest of all indicators to understand because it determines the safety of assets. Next time you hear the TALKING HEADS discussing the nuances of the markets, filter what they say through your own understanding of the Real Rate of Return.
The Real Rate of Return is the one number that determines the safety of principal. It is calculated by taking the current BOND YIELD and subtracting the expected INFLATION rate from it.The result is the REAL return on giaranteed money from the government.
Interest Rates are on the rise as we have been expecting andthis pressure has put a tremendous amount of pressure on thestock market. The essential simplicity at work here is very,very basic. If Interest rates on Bonds are yielding 5.14% andinflation is forecasted at 5%. The difference is the REAL RATEof RETURN, (in this instance we are speaking about .14%). TheREAL RATE of RETURN is what sparks major rallies and declines onWall Street.
The reason for this is that the Bond market is the largestfinancial market in the world. There are literally trillions ofdollars invested in debt denominated assets. These investorsare primarily interested in the security of their principal andtaking as minimal risk as possible. They historically have beenthrilled with REAL RATES of RETURNS that would be in the 2% - 5%annually. During the 1970's this indicator went NEGATIVE for awhile indicating INFLATION was rising faster than interest ratesand BOND INVESTORS actually had substantial negative returns.During this time there was much "screaming and gnashing ofteeth."
It has always been my estimation that Federal Reserve Chairman,Alan Greenspan's key task is to keep the REAL RATE of RETURN ashigh as possible. HE has been extremely successful at doingthis. If you read back over any history of the financial markets you would be WISE to view events through this indicator. The economic climate becomes remarkably different and people's opinions change dramatically when the REAL RATE of RETURN on the most SECURE investments is threatened.
A thorough understanding of this simplicity is necessary forsuccess in any kind of investing as IT is the basic buildingblock from which all other analysis is based. Although it isalways difficult to forecast what will happen in the future, theone factor you can count on is that when THE REAL RATE OF RETURNis falling there is much SWEAT on the brows of Money Managerswho monitor the trillions of dollars entrusted to them.
At this point KEEP YOUR EYES on this indicator and make your ownforecast of INFLATION. You'll realize that your ANALYSIS can bebetter than the Big Boys.
Let's be careful other there!
Harald Anderson is the founder and Chief Analyst of eOptionsTrader.com a leading online resource of Options Trading Information. He writes regularly for financial publications on Risk Management and Trading Strategies. His goal in life is to become the kind of person that his dog already thinks he is. http://www.eOptionsTrader.com.
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