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Despite the fact that the S&P is up over 80% in the last 21
months, US financial firms are currently tripping over each other in their
zeal to raise their S&P 500 and GDP targets for 2011. JPMorgan's chief US
equities strategist, Thomas Lee, came out on December 3rd with a
target of 1425 on the S&P for 2011, which would be a 15 percent gain.
Barclays Capital last Thursday released a 1420 estimate. Not to be outdone,
Goldman Sachs also recently released its forecast, and it sees a more-than-20
percent increase next year, to 1450. Meanwhile, PIMCO's idea of a "new
normal" has translated into a 2011 GDP forecast raised from 2-2.5% to
3-3.5% due to "massive" government stimulus.
In the midst of this collective 'hurrah,' very little attention
is being paid to what is going on over in the bond market. With my due
condolences to Fed Chairman Bernanke, the yield on the 10-year Treasury note
has increased from 2.33% on October 8th to 3.29% today. And, if
there is any notice at all given to that recent run-up in yields, it is
merely explained away as a sign of robust growth returning to the economy.
In reality, growth doesn't cause an increase in interest rates;
it is either lack of savings or inflation that is responsible. To refute the
'robust growth' reasoning, turn your attention to the fact that the spike in
yields just happened to coincide with the news that the unemployment rate
jumped to 9.8% in November.
A slightly broader explanation for the surge in borrowing costs
might be the failure of the Bowles-Simpson deficit commission to implement
any cost cutting measures. Or, perhaps it was the intimation from Bernanke
himself that QE III may already be under construction in his infamous
interview on 60 Minutes. Or, maybe it is the fact that the $150.4 billion
November budget deficit was the highest total for that month... ever, and was
the 26th straight month of red ink! I often wonder to myself,
where in the midst of all this good news do I summon a bearish attitude?
I think it's pretty clear that 'robust growth' is going the way
of 'green shoots' and knickers - right into the dustbin of history.
So, what will the increase in interest rates - ignored by all of
Wall Street - actually mean for the economy in 2011?
For starters, the National Home Price Index already fell 2% in
the third quarter of 2010. On a national basis, home prices are 1.5% lower
year-over-year, and 15 out of the 20 cities measured were down over the last
12 months. On a month-over-month basis, 18 cities posted a price decline in
September, compared to 15 MoM drops in August, and just 8 cities experiencing
price reductions in the July report. Therefore, home prices, which were
already headed lower before this recent spike in mortgage rates, are set to
take another tumble downward. According to Freddie Mac's weekly survey of
conforming mortgages, the average rate on the 30-year fixed is at its highest
level in six months. 30-year rates averaged 4.61% for the week ending Dec. 9,
up from 4.46% last week. It's the fourth week in a row that the mortgage rate
has increased. The ramifications for the real estate market and bank lending
are clear. Lower home prices will send more mortgages under water and force
many more homes into foreclosure. Higher borrowing costs will lower the
demand for borrowing and place more strain on the capital of lending
institutions.
On top of that, household debt as a percentage of GDP still
stands at a lofty 91%. It should be clear that with near double-digit
unemployment, the last thing consumers can now tolerate is a significant
increase in debt-service payments.
The rising cost of money is even worse news for the federal
government and its chronically ballooning debt problem. According to the
Federal Reserve's Flow of Funds Report, total non-financial debt reached an
all-time high of $35.8 trillion in the third quarter of 2010. In fact,
household debt, business debt, and government debt increased at a 4.2% annual
rate last quarter.
To put that record level of nominal debt into perspective: in
1980, the total non-financial debt-to-GDP ratio was 144%. In the height of
the credit boom, at the end of 2007, that figure was 226%. Today, the figure
stands at a mind-blowing 243%! So you can forget about all that deleveraging
talk. The US is in fact still leveraging up, both in nominal terms and as a
percentage of GDP.
I think the rising cost of money will become the story of
2011. Its effect on consumers, the real estate market, and government
borrowing costs will be profound. Apparently, most major brokerage firms have
no fear of soaring interest rates causing our economy to implode. However, it's
clear to me that the bond market has already started to crack due to
inflation and massive oversupply from the Treasury. Prudent investors should
think twice before overlooking what could be the initial holes in the biggest
bubble in world history - the full faith and credit of the United States.
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A 15-year
industry veteran whose career began as a trader on the floor of the New York
Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
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