Robert Wiedemer |
By Robert Wiedemer and Cindy Spitzer
Timing is always key to investment success, but there’s something even more essential: the accuracy of your macroeconomic view. Some of the biggest hits in hedge fund history were based on good macroeconomic analysis. For example, John Paulson and Jeff Greene used their macroeconomic view to cash in on the housing downturn. More recently, Julian Robertson, James Chanos, John Paulson, and David Einhorn are making bets based on their macroeconomic assessments.
For many investors, there was a time when not having a macro view didn’t matter all that much, but since the financial crisis of 2008, investing without the correct macroeconomic analysis is worse than flying without instruments; it’s like flying without an engine. Asset managers who focus only on individual company analysis often miss golden opportunities, and worse, they are blindsided when a macroeconomic freight train hits all the companies in a sector.
A macro view is crucial, but only if it is the right macro view. It’s important to question your implicit macro assumptions (we all have them), make them explicit, and update your macro view frequently (we suggest monthly) to maximize your timing accuracy in the dangerous period ahead.
In the short-term, we face no immediate danger. The government will continue to borrow and print money to avoid any major crises caused by commercial mortgage-backed securities, foreclosures, etc. But government spending can’t end this recession because it’s not a typical down cycle; it’s a multi-bubble pop and no amount of government stimulus can delay it forever.
Instead, all this borrowing and printing is just kicking the can down the road. Rather than stimulative Keynesian economics, we are merely postponing popping bubbles. Without real economic growth, high unemployment and economic unease will continue; home prices will remain soft or fall further; and eventually the current very positive investor psychology, that has driven stocks higher over the past nine months, will turn more negative. Unrealistically positive investor psychology has fueled the record-setting stock rally, but good psychology cannot last without real signs of recovery. Once the market drops below 9500, investor sentiment could reverse dramatically. Interestingly, the current rally (driven mostly by institutional, not individual investors) has tracked the growth in US money supply (M1).
And speaking of the money supply, are you aware that the Fed is effectively printing money with its quantitative easing (QE) program? At this point, rising inflation is baked in the cake for 2011/2012. Like falling home prices, it’s easy to think inflation won’t happen. But how can it not? Remember, our M1 is only $1.6 trillion. If Bernanke can magically buy $1.5 trillion worth of Fannie, Freddie, and treasury bonds with QE without creating significant future inflation, he deserves two Nobel prizes. It simply cannot be done. QE will cause inflation, and rising inflation will cause interest rates to inch up. After a while, the Fed will be caught between a rock and a hard place, forced to either let interest rates rise significantly or keep them low and continue to print money via more QE, which will create even more inflation. The dollar, long seen as a safe haven, has been supported by massive inflows of foreign capital into US stocks and bonds. Inflation, coupled with poor long-term returns, will reduce that massive inflow. As demand for the dollar declines, interest rates will only rise further.
In time, rising interest rates will put increasing pressure on the government debt bubble. Right now, the US is about $12 trillion in debt, and we’re adding to it faster than ever. In fact, in December, which usually shows a surplus, the deficit nearly doubled from December 2008 to a monthly deficit of $91 billion in December, 2009. To get a real feel for what this means, rather than comparing total US debt to GDP, it’s better to compare total debt to the government’s ability to repay—which is its income (tax revenue). Our debt is already six times our income (see Figure 1). If the US was a business entity looking for a commercial loan, would you lend it more money?
What is the government’s credit limit? We estimate it near $25 trillion. Rising interest costs will be our Achilles Heel. Interest rates are key because the US is the largest holder of adjustable rate debt in the world. About 36 percent of its debt has a maturity of less than one year and the average maturity is only 4.3 years. Since we never repay this debt, only refinance it, when rates go up, we have to make bigger and bigger payments, and the only way we can do that is to borrow more and more money. In time, the interest payments on our debt could consume all of our tax income (see Figure 2).
How long will foreign investors want to buy our debt under these conditions? At some point, the unthinkable will happen and the US government will reach its credit limit. Hard to imagine now, but a future treasury auction failure is a real possibility.
As always, timing is key to limiting investment risk and maximizing opportunities at each stage of this multi-bubble fall. Even more critical is to have the right macroeconomic view and to update it monthly.
Robert Wiedemer is the president and CEO of the Foresight Group, a Macroeconomic Consulting firm in the Washington, DC, area.
Cindy Spitzer is Chief Communications Officer for the Foresight Group and the coauthor, along with Robert Wiedemer and David Wiedemer, of America’s Bubble Economy(2006) and Aftershock (2009).
