Equities still represent a solid investment

Serious Money: Old codgers like me invariably end up believing that there is nothing new under the sun - at least in financial markets.

I have cheerfully used that old cliche when pinching other people's good ideas: if nothing is original, no one can claim ownership. I've spent the last couple of weeks explaining, not terribly patiently, how and why bond markets are so important for equities. This really was a blast from the past - as this column has remarked on several occasions, bond yields are the single most important determinant of everything.

They may not have been responsible for the big bang but they determine your mortgage, the value of your shares and the size of your pension.

So, the sudden outbreak of interest in bonds should really come as no surprise. People shouldn't have forgotten about them in the first place. But financial markets are funny places, full of people with more degrees than is healthy and brains the size of a small planet; yet most are unable to remember the first chapter of any standard finance text book.

Markets share a number of characteristics with the saloons of the old wild west: feverish gambling, chaos, violent and rugged individualism may be obvious similarities, but recall that many of the older establishments asked people to leave their guns at the door.

Today's markets seem to require many people to leave their brains at the main entrance.

Equity markets have sold-off because, it is said, bond yields have gone up. Moreover, those yields have risen because central banks everywhere are putting up interest rates. Gosh, there's a surprise!

Why are interest rates going up? Let's take a semantic step back and ask what we mean by "up".

What has been happening for some time in the US, more recently in Europe and has yet to happen in Japan (but looks more imminent than it did) is a removal of an emergency interest rate. That's an important qualification.

Rising interest rates, it is generally reckoned, are bad. Historically, such an argument does have a lot going for it. Typically, central banks raise rates when they see an inflation problem. Historically, most central bankers have actually done a lousy job; rates have often been raised at the wrong time and have rarely been moved by the right amount.

The great depression of the 1930s was caused by madmen around the world pushing interest rates up to unsustainable levels.

The inflationary decade of the 1970s was largely the result of central bankers (and, it has to be said, politicians) utterly failing to see the wage-price spiral which developed following Opec-inspired oil price rises.

Other less extreme examples of interest rate idiocy are legion.

Monetary masochism has been a dominant feature of the European economy for the past couple of decades. Grey men in central banks have been tilting at the inflation windmill for most of my career, convinced that if any price - any price at all - is allowed to rise, Europe will again be plunged into war. Or something like that.

In the early part of 2000, the greatest stock market bubble the world had ever seen burst.

We weren't sure what this meant, but most of us were convinced that nothing good would come of it. The one man absolutely sure of this was Alan Greenspan, then chairman of the US Federal Reserve.

He quickly reduced US interest rates to 1 per cent, a level that is abnormal and justified only by the most extraordinary circumstances.

Greenspan was and is a very clever chap, but circumstances were abnormal. Without his pressing on the monetary accelerator the US would have gone the way of Japan, which at the time, because of a typical monetary mess, was two-thirds of the way though a 15-year slump.

The real mystery of the past few years was how Greenspan, "Maestro" to his friends, managed to persuade his Frankfurt counterparts to follow suit. European rates at 2 per cent were nowhere near low enough but, all things considered, should also be seen as an emergency level.

So, rates are going up. Anyone paying attention might be tempted to think that the reason why interest rates are on the rise is because the emergency is over.

Not a bit of it. Our typical gun slinging financial commentator has come out with all brains missing, and declared that higher interest rates mean just what they always have - bad stuff is about to happen. Conclusion: sell equities.

Apparently, according to our sharp-shooting analysts, we have - every single one of us - been borrowing up to our necks (if not beyond), availing of the emergency interest rates, and we are now due to get our comeuppance as rates rise.

And it's not just property that will implode thanks to monetary tightening. More esoteric asset classes - particularly commodities - will collapse as the liquidity bubble bursts. Apart from borrowing excessively to buy over-priced houses, we have all been buying copper futures on our overdraft. Hence, mining stocks, particularly those exposed to copper-price fluctuations, have been having a torrid time of it.

Regular readers will know what is coming next. If the recent sell-off in equities continues, we will be revisited by our old and welcome friend, the buying opportunity.

I would be much more worried if interest rates weren't going up.

The gentle rises which we are seeing mean that things are finally getting back to something approaching normality. That means that the world is becoming a slightly less risky place.

Moreover, those first-year text books tell us that when risk falls low, all asset prices - particularly for equities - go up. End of story.

Chris Johns is an investment strategist with Collins Stewart. All opinions are personal.