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Markets usually react to news in a millisecond. There are some market factors, however, that have a slower burn. Prices take longer to adjust because a trend creeps up on us, runs counter to our previous experience, or is expected to return to historical levels.
Skeptics like me have a rule that new economic and cultural trends are cyclical until proven otherwise. They can’t be declared sustainable until they’ve shown themselves to be more than just a cyclical upswing.
Bond Bonanza
The best example of a slow burn occurred in the 1980s and 1990s. At that time, inflation was declining steadily from double-digit levels. Interest rates followed along, as is usually the case, but they lagged. That’s because a generation of bond investors couldn’t get hyper-inflation out of their minds. Nor could they envision the Consumer Price Index (CPI) trending all the way down to low single digits.
The result of this skepticism, or should I say, slow adjustment, was that interest rates stayed well above inflation. “Real” yields (the excess yield above CPI) were exceedingly high (three to five per cent) for almost twenty years starting in the mid-1980s.