Debt ceiling: Mr. Market's take...
It's fun to tell you what we think. And after all, that's our job. But you have to check in with Mr. Market, too. He's a manic-depressive who knows the price of everything and the value of nothing. He's far from perfect, but he's all we've got. What does he think about the debt ceiling debate?
Neither the bond nor the stock markets like the debt ceiling debate much...
Both the 10- and 30-year Treasury yields have risen the past few weeks, as the debt ceiling debate has heated up. Yields rise when prices fall.
After declining over the past six months, the 30-year Treasury bond rate is higher (signaling greater risk and a lower price) over the past year. The 10-year bond rate is about flat versus a year ago.
Also, 30-year mortgage rates are at their highest in three months. Freddie Mac reports 30-year fixed rates at 4.55% for the week ending today, up from 4.52% the previous week. So the mortgage market isn't crazy about the debt ceiling business, either. That's probably because a downgrade of the U.S. Treasury's debt would likely mean a downgrade of Fannie and Freddie's securities, too.
Mike Englund, chief economist at the economic research firm Action Economics, told Bloomberg in an interview yesterday, "What we lack in the mortgage market is confidence in the longer-term economic outlook. A good portion of the country thinks the government is going to default fairly imminently."
The S&P 500 is down slightly over the last three months, as the debt ceiling show has taken over the headlines.
Stocks look a little different than bonds. The S&P 500 is almost 20% higher than one year ago. It's also up over the last six months (by about 2%).
Overall, Mr. Market is definitely concerned. But he's not freaked out yet.
There are other markets to think about, too. PIMCO co-CEO Mohamed El-Erian says the first thing he does every morning is ask the money-market people on his trading desk what's happening. The money market is gigantic… bigger than the stock market. It involves instruments with maturities of less than one year, including U.S. Treasurys, CDs, and commercial paper. It's basically the liquidity for the global financial system. If you need cash quick, you go to the money market to get it.
El-Erian says of the money market, "So far it's functioning OK, but we're seeing some pressure." Again, there's concern… But the market is not freaking out.
The precious metals markets seem to think something bad is happening... Gold is hitting new highs and has risen more than 20% since January. It's up about 9.5% since July 1. Silver is up about 20% this month.
What do I think? I think this will be a case of "buy the rumor, sell the news." In other words, market anticipation of a default has built up so much that once August 2 arrives and everyone realizes there's no immediate crisis, the market will rally.
Either way, this looks like a classic case of everyone being obsessed with headlines and anticipating a great, big, scary boogieman. When it actually arrives, the feared event will look smaller and less scary.
The odds of a default on U.S. Treasury debt are nil, at least in the near term. The government will bring in about six times the cash flow needed to pay the interest on the Treasury debt next month. And the issue of rolling over Treasury debt doesn't seem like much to worry about, either, since old debt is replaced with new, and the net debt doesn't rise.
Perhaps the real worry is that the credit ratings agencies will downgrade the U.S. Treasury's debt. The current rating is triple-A, the highest possible rating. If it's downgraded, it'll probably wind up with a double-A-plus rating. In that case, the government's interest expense on new debt is expected to rise by perhaps 50 or 60 basis points.
Or will it? A Forbes piece recently pointed out that S&P downgraded Japan's sovereign debt to double-A-minus at the beginning of the year. Interest rates for 10-year Japanese government bonds hit 1.085% a few days ago, a new seven-month low. Fund manager Lacy Hunt of Texas-based Hoisington Investment Management thinks the Treasury market already has about 0.3% (30bps) of downgrade/default risk baked into it. So maybe when the downgrade happens for real, the market won't react so badly... or at all.
Yet Hunt is a realist, pointing out that even if interest rates stay where they are today in real terms, interest expense will eclipse defense spending by the end of this decade. He knows the real problem is a long-term challenge that will only get worse without drastic action from the government.
Next week should be interesting, but I'm tired of all this debt ceiling stuff. I'm going to distract myself this weekend by attending a concert by Yes, a rock band that had its heyday in the 1970s. They play 20-minute songs and nobody knows what the lyrics are about. They're my favorite band of all time, and the members are all 60 years old.
Sitting right in front of the stage (with earplugs in!), outdoors under the stars, listening to Yes one more time before the old geezers quit touring will take me about as far away from debt ceiling nonsense as I can get without flying more than one hour. When in doubt, retreat to the '70s.
Then again, there was this one big, bad, ugly thing about the '70s we shouldn't forget. What was that called again? Oh yeah, I remember...
Inflation. If you want evidence of inflation happening right here and now, look no further than Visa. The world's biggest payment processor announced blockbuster earnings yesterday. Third-quarter earnings rose 40% to $1 billion from $716 million a year ago, beating analysts' estimates.
Visa's value as an inflation hedge is easy to understand. It controls around 60% or so of the global payment-card market. So it gets the lion's share of the growth when more money is sloshing around the world. The more currency units in the world, the more money Visa makes. Porter wrote about this phenomenon in the June 2009 issue of Stansberry's Investment Advisory…
|
Why is Visa an inflation hedge? Visa operates the world's largest retail electronic payments network and manages the world's most recognized global financial services brand. Visa has more branded credit and debit cards in circulation than anyone else. |
|
And... this is the key: The financial institutions that license their brand do so on the basis of transaction volume. The more money people spend on their Visa-branded debit and credit cards, the more money Visa earns. (This is important: Visa doesn't hold any of the debt put on those cards. It merely licenses the brand and receives a fee for processing the transactions.) |
|
Ergo, the more money that exists, the more money Visa will make. It's perfectly correlated to inflation. And Visa has the most to gain from inflation out of all of the credit-card networks because it is the largest, by far. Last year, Visa processed more than $3.8 trillion from more than 50 billion separate transactions. American Express processed 5 billion transactions worth $647 billion. |
Worldwide spending on Visa debit and credit cards climbed 13% to $941 billion in the quarter. So maybe the true global rate of inflation is closer to 13% than to the low single-digit numbers reported by the government.
A real increase in wealth certainly isn't responsible for the higher spending... Unemployment is still more than 9%. And the most recent initial jobless claims came in at 398,000. (That's below the expected 415,000, but still 398,000 more people without jobs.)
And companies are still announcing large layoffs. Today, the big medical-device firm Boston Scientific – in addition to announcing good earnings – said it will layoff 1,400 people. Credit Suisse said it would cut 2,000. And HSBC announced today it's considering 10,000 cuts. We've noted the massive financial-sector layoffs before... The big banks see the writing on the wall. It's going to be much harder to make money without free-flowing credit (as we've had for the past 30 years).
If you are retired or plan to retire soon, you must watch the new video Dr. David Eifrig created.
In it, David describes how over the past few years, the government has passed a series of laws that take control of some of the most intimate decisions you'll make in preparing for retirement. For example, these laws give the federal government great ability to draw down the value of your 401(k) or pension benefits. And it's putting in place huge changes to the national health care regime – including rationing of health services.
In his new video, David explains that he has laid out a plan to insulate subscribers of his Retirement Millionaire service from these changes and allow them to retain control over their finances and their health. You can watch the video here.
While the U.S. debt ceiling debate is stealing the headlines, Europe is still melting down... Italy in particular. The Italian government auctioned $11.45 billion of bonds today.
Italy tried to sell 3 billion euros worth of its 10-year bonds, but the market got its fill at 2.7 billion euros. Funding costs on the 10-year bonds rose to 5.77% from 4.94% at the previous June 28 auction.
Interest rates are rising that much… even with an implied government backstop. Sounds like somebody is losing faith in government backstops.
|
New 52-week highs (as of 7/27/11): Exelon (EXC).
Are you worried about a U.S. default? Let us know here... feedback@stansberryresearch.com
"I've always loved the way you write OBAMA! It captures what he's all about perfectly. Keep up the good work." – Paid-up subscriber Matt
Good investing,
Dan Ferris
Medford, Oregon
July 28, 2011
Debt ceiling: Mr. Market's take... Metals don't like it... 'Sell the news'... Visa: 13% inflation?!... Retirees: Doc's new must-see video... Italy: Higher debt costs... U.S. Treasury debt: Higher default risk...