By Scott Moser, CPA/PFS, MST
We made it through two traditionally bad months in the market – September and October! For the month of October the S&P 500 was up 3.9%. Since six of the last ten most recent bear markets hit bottom in October, successfully getting through October can be an important milestone. Unfortunately, our economy still faces challenges. For every dollar spent by the U.S. government for the 12 months ending September 30, 2010, it collected just 63¢ in tax revenue. It’s a great prescription for going broke quickly. (Source: U.S. Treasury Department). And despite the deficit spending, the Treasury was able to sell $10 billion worth of Five Year Treasury Inflation Protected Securities (TIPS) at a negative yield for the first time ever! Investors buy TIPS to protect against inflation, and there is so much fear of future inflation the yield on these Five Year TIPS was a -0.55%. That’s correct! TIPS buyers are willing to pay the Treasury to hold their money in exchange for a payment equal to the future rate inflation rate. Since the current rate of inflation is approximately zero, this appears to be a dubious trade. As of September, 4.7% of our composite portfolio was allocated to TIPS; it’s likely we’ll be reducing this position. Alternative holdings such as energy and metals that also provide protection against inflation appear to provide more attractive values. U.S. investors are clearly placing a huge premium on high quality bonds in this liquidity crisis. Americans have over consumed debt and must now significantly rein in their diets. Jeremy Grantham, in a Quarterly Letter entitled “Night of the Living Fed,” makes the compelling argument that debt doesn’t correlate with long-term growth rates. Debt, he writes, “is the paper world. In the real world, growth depends on real factors: the quality and quantity of education, work ethic, population profile, the quality and quantity of existing plant and equipment, business organization, the quality of public leadership (especially from the Fed in the U.S.), and the quality (not quantity) of existing regulations and the degree of enforcement. If you really want to worry about growth, you should be concerned about sliding education standards and an aging population. All of the real power of debt is negative: it can gum up the works in a liquidity/solvency crisis and freeze the economy for quite a while.” If Jeremy is correct, the inevitable reduction in Americans appetite for debt will cause U.S. Growth rates to contract for a number of years delaying the inflation that generally accompanies massive government stimulus spending. Of course, it’s unlikely the adjustment process will even begin until the FED completes its stimulus efforts. |
