Of all the different elements of the economy, the direction of interest rates is most important. That’s why, as the editors of Profit Confidential, we expend a considerable amount of our time analyzing and providing guidance on interest rates. We believe that the unprecedented debt the U.S. has accumulated will eventually result in foreign investors demanding a better return on U.S. Treasuries. Too many U.S. dollars in circulation will also eventually force interest rates to rise.
Economics 101 suggests inflationary pressure builds during periods of low interest rates. The demand usually increases when people both borrow and consume more. As the price of goods and services is directly correlated with demand, it increases—resulting in inflation.
To tackle inflationary pressures, central banks increase interest rates. Why? Because once they increase interest rates, it is supposed to do the opposite of lowering the rates—forcing people to save and cut back on discretionary spending.
Following a 30-year down-cycle of interest rates in the U.S., we are on the cusp of a new 30-year up-cycle in interest rates; a move that could cripple the government and the economy. This is mainly because the government has added too much debt to its balance sheet, and the Federal Reserve has printed significant sums of money.
After phenomenal amounts of bailouts were doled out, followed by non-stop government spending, the U.S. national debt rose 76.2%—from $9.2 trillion in 2008, to $16.3 trillion in 2012. (Source: TreasuryDirect, last accessed November 27, 2012.)
It gets worse. The current administration said it would keep the budget deficit below $1.0 trillion. It hasn’t. For fiscal 2012, the federal budget deficit was $1.1 trillion, slightly below the $1.3 trillion deficit recorded in 2011. (Source: U.S. Department of the Treasury, October 12, 2012.) What’s more, 2012 marked the fourth consecutive year in which the U.S. government experienced an annual deficit above $1.0 trillion. As a percentage of gross domestic product (GDP), the U.S. government’s budget deficit for the year 2012 stands at seven percent.
Along with skyrocketing government debt, the Federal Reserve has printed $3.0 trillion. Where did the $3.0 trillion come from? It’s not backed by gold. It was simply created out of thin air. And, the presses continue to print an additional $85.0 billion a month!
Looking at an even bigger picture, between January 2000 and September 2012, the amount of U.S. money in circulation (the “M1 money supply”) has increased 112%, or $1.25 trillion. That’s a lot of money printing.
Similarly, the “M2 money supply,” which includes the M1 money supply plus savings deposits, balances in money market mutual funds, and deposits, has increased 118%. M2 is a better measure of actual money supply. Since the beginning of 2000, M2 money supply has increased more than $5.4 trillion. (Source: Federal Reserve, October 11, 2012.) Again, the printing presses have been in overdrive.
Now think of it this way; as more money is created and more debt is added to the federal government’s balance sheet, U.S. economic viability becomes questionable. What does this mean? The interest rate at which the government is currently able to borrow is being kept artificially low. With the government adding more debt and the inflationary pressure building—something has to be done.
As the key stock indices continue to climb higher, optimism amongst investors and stock advisors rises to a dangerous level.
According to the Advisor Sentiment tracked by Investors Intelligence, an indicator I follow to gauge optimism in the stock market, the number of stock advisors who are bullish towards key stock indices is at its highest since April of 2011. (Source: Investors Intelligence, May 22, 2013.) To bring this into perspective, in April of 2011, the key stock indices like the S&P 500 started to decline, dropping nearly 20% through October of that year.
The stock market is becoming very overbought and very overpriced. It’s not a matter of “if” the market faces a major set-back, but “when.”
The U.S. economy continues to struggle and early indicators of economic slowdown are flashing warning signs. Consider the Business Outlook Survey by the Federal Reserve Bank of Philadelphia, which provides an outlook for manufacturing activity in the Philadelphia area. The survey indicates demand has been weak, with new orders and shipments declining and inventories building up. (Source: Federal Reserve Bank of Philadelphia, May 16, 2013.)
The index of current manufacturing activity in the Philadelphia region registered at negative 5.3 in May compared to positive 1.3 in April. Any number below zero indicates conditions in the manufacturing sector are becoming poor.
This isn’t the only troubling statistic that shows the U.S. economy is headed towards an economic slowdown. Our economic growth is questionable; unemployment is still staggering; the majority of jobs created since the financial crisis have been in low-paying jobs, and a significant portion of the U.S. population is on food stamps…. Read More
While testifying in front of the Joint Economic Committee in Washington regarding monetary policy and the economic outlook of the U.S. economy, the Chairman of the Federal Reserve, Ben Bernanke, said yesterday, “…the committee has said that it will continue its securities purchase until the outlook for the labor market has improved substantially in a context of price stability.” (Source: “The Economic Outlook,” Board of Governors of the Federal Reserve System, May 22, 2013.) In other words, the Federal Reserve has made it clear, once again: it will not stop quantitative easing until the unemployment rate comes down.
The Federal Reserve continues printing $85.0 billion a month in new money, using this newly created money to purchase long-term U.S. bonds and mortgage-backed securities (MBS). The Fed has already inflated its balance sheet to over $3.0 trillion, and by keeping the pace of quantitative easing the same, its balance sheet will reach $4.0 trillion very quickly.
I believe the longer the Federal Reserve continues with the quantitative easing, the bigger the eventual troubles will be.
First of all, quantitative easing and artificially low interest rates by the Federal Reserve have essentially forced investors to take higher risk elsewhere, as guaranteed yields have collapsed. The yield on 10-year U.S. bonds is less than two percent; meanwhile, tax-favored dividends from the rising Dow Jones Industrial Average stocks pay 2.35%.
It is very well documented in these pages how investors are rushing to get higher yields as the Federal Reserve stays the course. Investors are adding junk bonds to their portfolio; conservative investors, like the central banks, are buying stocks; and bond funds … Read More
There very well could be more upside in the Dow Jones Industrial Average.
Many components have been underperforming the stock market significantly; if there is to be any real economic recovery, these companies should feel it.
As an index, the Dow Jones Industrial Average seems a little out of date and not particularly reflective of today’s world or the rest of the stock market.
But regardless, it’s still the global benchmark, and ownership of both the index and component companies is vast.
Even though Merck & Co., Inc. (NYSE/MRK) is a great pharmaceutical company (and dividend payer), on the stock market, the position is back to where it was in 1997.
Another Dow Jones component looking for improvement is Hewlett-Packard Company (NYSE/HPQ), which has its own specific set of problems.
Then there’s Alcoa Inc. (NYSE/AA), which reports early. This stock market laggard is still trading at the same level it was in 1989, taking share splits into consideration.
And there are several other Dow Jones components that are laggards.
It’s pretty clear that institutional investors have made a profound bet on the safest blue chips, most evident in January and February.
While business conditions for a lot of companies are flat, both interest rates and monetary environments remain very accommodative. In addition, there are efforts being made regarding fiscal policies in many important economies.
China effected a policy to slow its frothy economy and real estate market, and it succeeded.
So, with many countries trying to get their fiscal affairs in order, the potential for genuine economic growth (in a year or two) is being cultivated.
If this came … Read More
Looking at the monthly budget statement from the Department of the Treasury, in fiscal 2013, year-to-date (that’s October 2013 to this April), the U.S. government has already paid interest of $227 billion on its national debt. For the entire fiscal year 2013, the government expects to pay a little more than $420 billion in interest payments. (Source: U.S. Department of the Treasury, Financial Management Service, May 10, 2013.)
If I calculate the amount of interest payments relative to the national debt outstanding, which is around $17.0 trillion, the U.S. government is paying interest on the national debt at the rate of about 2.5%.
Now, look at these two scenarios…
If we assume that the U.S. national debt will be $23.0 trillion by 2023, then the interest payments on the debt will rise to about $575 billion, not taking interest rate changes into account.
If in 10 years from now, interest rates go back to historical levels and double to five percent, interest payments on the national debt will exceed $1.0 trillion per annum. 2023 is 10 years from now. You can be assured the economic environment will be very different one decade out from today.
But as I wrote the other day, according to the action in the 30-year Treasury market, interest rates may already be on their way up.
Since their peak in July of 2012, the 30-year U.S. bonds have declined in value—they are down almost six percent. Trading above $153.00 in mid-2012, 30-year U.S. bonds now hover around $144.00.
Take a look at the chart of 30-year U.S. Treasury bond prices below:
Chart courtesy of www.StockCharts.com
As … Read More
The fact is that Japan is finally beginning to see some results from Prime Minister Shinzo Abe’s aggressive strategy to inject $2.4 trillion into the Japanese economy over the next decade.
Maybe this time it’s for real. Previous attempts to drive Japan’s economy out of its economic tailspin have failed. Of course, it will take some time, and success will depend on the continued weakness of the yen and a pickup in the global economy, especially with the country’s key trading partners in China.
If the first quarter was any indication, the despair in Japan may be finally coming to an end after decades of disappointment; but again, it’s only one quarter.
Japan saw its gross domestic product (GDP) surge 0.9% in the first quarter or an annualized rate of 3.5%, according to data from Japan’s Cabinet Office. (Source: “Japan GDP Rises 0.9% On Quarter In Q1,” RTTNews, May 15, 2103.)
What’s also interesting is the rise in private consumption in Japan, which contributed to 2.3% of the 3.5% GDP growth. The upward move in consumer spending is critical, as a large part of the economic renewal in Japan will be dependent on consumer spending as is the case in the United States. According to Trading Economics, consumer spending accounted for about 60% of GDP in Japan, so it’s essential.
While it’s still way too early to see if Japan is on the path to growth, the country’s … Read More
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