Basically, it is imperative that investors draw distinctions between the secular, or long-term, forces and the cyclical, or short-term, forces that shape the outlook on an investment. By drawing these distinctions, can more easily spot opportunities in the markets. Investors are best advised to let the secular forces shape their investment decisions simply because secular trends stay in place for many years at a time, whereas cyclical forces last usually for just a few quarter, months, or weeks at a time.
In 1994, in response to signs that the economy was growing strongly, long-term interest rates rose sharply from a low of 5.78 percent in October 1993 to a high of 8.17 percent in November 1994. While there’s no question that the Fed’s six rate increases in 1994 were responsible for much of that rise, that's not the full story.
As bond-investment theory goes, long-term interest rates include both the market’s forecast of future short-term rates and its inflation forecast. Therefore, the sharp rise in yields that year was partly a reflection of the market’s inflation fears. Inflation, mind you, that never reared its head that year and beyond.
But before the bond market was able to see the forest from the trees, for that short time in 1994, it put more weight on factors that might affect the (cyclical) , but not the (secular) one. Investors who were able to draw that key distinction benefited greatly. In 1995, the total return on bonds was more than 30 percent.
A similar story has been seen time and time again with regards to the technology sector of the equity market. There have been countless periods where talk of “slowing PC sales,” or “slowing chip sales,” and the like have knocked down stock prices in the technology sector for brief periods before they resumed massive up-trends again. Has it ever been realistic to think that one or two month’s slowing in either PC or chip sales meant that the technology boom was over? Of course not.
The point is Yields apparently skyrocketed in 1994 due to cyclical fears, not secular ones. How do we know this? Yields eventually resumed the downtrend that had been in place since 1981. Yes, 1981!
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