 Who will determine the fate of our bond market, our stock market and, ultimately, the fate of our entire economy?
I can assure you it’s not going to be the U.S. Congress or the President of the United States. If they could exercise that degree of influence or control, we would never have bear markets and never experience a recession. Nor will it be Alan Greenspan, Ben Bernanke, or anyone else at the Federal Reserve. Yes, they may have some control over short-term interest rates. But they have very limited influence over long-term rates. And they’ve been unable to do a darn thing to stop booms and busts in the stock market. Normally, I’d say the ultimate decision makers are you and me, along with millions of other American investors, savers and consumers. But, alas, even that is not the case any more. Rather, today … We Find Ourselves in the Unenviable, Highly Vulnerable We need foreign investors to pour money into our bond market to continue financing our bulging budget deficit. We need them to pour still more money into our stock market to keep it aloft. Plus we depend on their money to maintain the borrow-and-spend lifestyle of millions of American consumers. With their generous support, we can go on. Without it, we must stop, and watch our markets sink and our economy slump into recession, or worse. This conclusion is not speculation; it is a well-documented, widely-recognized fact, duly supported by data provided by the U.S. Treasury Department, the Federal Reserve Board and the U.S. Department of Commerce. We know, without a shadow of a doubt, that we have been buying much more from overseas than we have been selling in return. We know that we have been doing this year after year, and that the gap — the U.S. “trade gap” — has grown larger and larger. And based on yesterday’s report from the Commerce Department, we also know that this gap …
Each year, foreigners lend us more money. And each year, we give them, in exchange, more of our bonds and other pieces of paper. That’s debt. And it’s a debt that keeps piling up. Indeed, the total pile-up of debt we owe foreigners today is larger than our entire economy was just a few years ago. It Is the Greatest Financial Scandal of Our Time, Economists talk about it all the time. But our government officials do nothing whatsoever to change it. They say it’s “OK.†They seem to think it’s the normal state of affairs and that it can continue pretty much indefinitely. They’re wrong. When I was a teenager, I went to high school in Brazil. I saw with my own eyes what can happen to a country that depends too heavily on foreign capital. I saw the tremendous internal instability that it engenders — rampant inflation, hyperinflation and then depression. I witnessed firsthand the social and political upheavals that ensue. Many other countries in Latin America and Asia — Argentina, Chile, Indonesia, the Philippines, for example — suffered even greater instability, for similar reasons. Germany after World War I, although a more extreme situation, was also overly dependent on foreign capital. No one wants to see that happen to the United States, or even come close to happening. And yet it is coming close, much too close for comfort. The United States used to be different because it was a big lender — not a big borrower, like those other nations. But that is no longer the case. Now, in absolute terms, the United States is the biggest borrower, bigger than any country in history. And even in proportion to the size of our economy, we’re not that far from the situation I saw in Brazil when I was growing up. The United States is also different in that it plays a more important role in the world’s financial markets than those countries did. But even that difference is now beginning to fade with the rise of the euro and the rapidly growing financial muscle of Asian economies. This Isn’t a Far-Away Threat. We witnessed one critical consequence of our dependence on foreign borrowing just this week — at the regular auctions of the U.S. Treasury Department. The Treasury Department holds similar auctions each month. As with any auction, it takes in bids from potential buyers and then awards the goods to the highest bidders. The main difference: The goods are not SUVs on a car lot or Louis XV antiques in a warehouse. They’re Treasury notes and bonds issued to raise money for the U.S. Government. And as you well know, the government needs the money to pay off massive amounts of old debts coming due … and … to borrow still more money to finance the equally massive current deficit. In recent years, this has not been a big problem because the lenders from overseas have been so numerous and so large. So the Treasury Department has come to depend on the heavy participation of foreigners in the regular auctions. When foreign investors are big buyers, all goes well. When they’re not, it can be very messy, and this week provided a prime example of both situations: On Wednesday, for example, most of the usual buyers from abroad failed to show up. Or if they came at all, it was with a lot less money in their pockets. Instead of bidding for almost 46% of the Treasury’s 5-year notes like they did last month, they bid for only 21% of the notes. Treasury- bond prices plunged. On Thursday, in contrast, the buying from foreigners was strong. Result: Treasury- bond prices rose. To the average investor, this doesn’t mean very much. “Who cares — or even knows — about Treasury auctions?†is the typical attitude. What they don’t realize is that what happens in the U.S. Treasury bond market directly or indirectly impacts:
Treasury Bonds Are in
But 30-year Treasury bond prices are now locked in a steep slide that is virtually unstoppable. The slide began in earnest in late August, and it has continued down the same slippery slope ever since, with only brief interruptions. I’ve pointed this out to you before. Now, if you haven’t done so already, I want you to recognize the fact that it is a trend that could hurt most of your investments. And this trend is not only in the longest-term 30-year bonds. It’s also severely impacting the nearer term 5-year Treasury notes.
This kind of broad interest-rate surge must, by definition, spread to every form of borrowing by every individual and institution in America. IF I were talking merely about a thin line on a flat chart, relying strictly on the tea leaves of technical analysis, it might not be worthy of our serious consideration. But this is a trend that’s driven by some of the most explosive and tenacious forces of our era — ramping-up inflation, the record-smashing trade deficit, the still-bulging budget deficit, the vast accumulation of debts in America, and alas, the huge pile-up of debt owed to foreigners. IF, as I said from the outset, these forces were in the hands of our leaders or even at the mercy of U.S. investors, it would not be nearly as serious. But that is not the case. As you can see from the topsy-turvy Treasury auctions … from the continuing decline in bonds … and from the record-smashing $66.1 billion trade deficit in September … we are not in control. IF this bond decline were a sideshow in the financial arena, I would refrain from dedicating more space to it here. But that is also not the case. Falling bond prices will drive mortgage rates higher, puncturing the great housing bubble. They will drive up the cost of all borrowing, felling the stocks of heavily-indebted companies. They will drive down bank stocks and insurance company stocks. And they could hurt a wide range of other investments you own as well. Finally, IF these worrisome trends were not replicated in society at large, I might not be as alarmed. But, that too, is not the case, as Tony shows with his reports about the impacts on the housing market across the U.S.
I don’t watch the numbers from the Fed, Treasury or Commerce quite as closely as Martin and his analysts in Florida. But I do stay in close touch with varied voices across America … Atlanta, Georgia A savvy reader sent me this email in response to some of my comments about the boom and bust in cash-out refinancing:
Of course Atlanta is just one city. But it also happens to be one of the great cities of America and one of the fastest-growing in the Southeast. If Atlanta is struggling, you have to wonder what is happening to the rest of the country. Newport Beach, California PIMCO is to bond funds what Fidelity is to stock funds. The people at PIMCO are some of the most knowledgeable fixed-income managers in the world and very worthy of attention. But Scott Simon, head of PIMCO’s mortgage department, had some less than enthusiastic things to say about the real estate market.
Indeed, rates on 30-year mortgages have climbed to the highest level in 16 months and have been stubbornly over 6% for the past month. Now, more and more smart investors are recognizing that there’s no way rising mortgage rates can possibly be good for the housing market. Horsham, Pennsylvania Toll Brothers, one of America’s largest homebuilders, warned Wall Street this week that business is rapidly slowing down.
What Toll Brothers is talking about is the jump in the cancellation rate to 6.5% last quarter. To put that in perspective, Toll Brothers has averaged a 4% cancellation rate over the past two years. Looking forward, Toll Brothers told Wall Street to lower its 2006 sales targets from the 10,200-10,600 range to the 9,500-10,200 range. This is blatant evidence of what Mike Larson, Money and Markets’ housing market maven, has been warning us about for quite some time. But Wall Street doesn’t quite see it yet. Indeed, one particularly blind analyst even characterized Toll Brothers’ problems as “company specific.†We don’t think so, and we doubt you would buy that either. Kalispell, Montana My wife says that I remind her of Tim “The Tool Man†Taylor. I think she says that because a couple of my home remodel jobs have often taken twice as long and cost twice as much as they would if I had hired a professional. But that wouldn’t be half as fun! Yesterday, for example, I made a trip to Home Depot and paid $6.40 for a sheet of 4 X 8 sheetrock. In early October, I paid roughly $9 for the same product. I can tell you that companies don’t lower prices when demand is booming. So this near-30% drop in price should make you question how healthy the real estate market is. I know that Montana is a long ways from Wall Street and I know the pinstripe suit crowd probably thinks we still hunt buffalo and fight wild Indians. But from my chilly perch, I see some very obvious signs that the housing market has or is about to top out. That has some important implications for investors: 1. Avoid homebuilder stocks like the plague. That goes without saying. 2. While companies like D.R. Horton and Toll Brothers may be pounding the nails, the companies that make the components that go into building a home are equally at risk. We’ve already heard warnings from American Standard (toilets) and Masco (cabinets) … and they won’t be the last. 3. Several furniture makers have also reported worse than expected Q3 results. Stanley Furniture, Hooker Furniture, and La-Z-Boy are all complaining about weak demand. 4. Mortgage lenders could get hit with a double whammy. Rising mortgage rates have killed the refinance game and a slowdown in real estate sales will exacerbate an already tough environment. That’s why Countrywide Financial missed its Q3 profit target and lowered its full-year 2005 results at the end of October. You can bet that Washington Mutual, Golden West Financial, and other mortgage lenders are in the same boat. Bottom Line: Our Warnings and 1. Put most of your keep-safe cash in 3-month Treasury bills or money market funds that invest exclusively in short-term Treasuries or equivalent. Examples: American Century Capital Preservation Fund (CPFXX; 800-345-2021) Dreyfus 100% U.S. Treasury Fund (DUSXX; 800-645-6561) 2. Reduce your exposure to the riskiest stocks, especially those that are sensitive to rising rates. And register at www.WeissWatchdog.com for instant Weiss ratings and follow-up e-mails. 3. Maintain your core positions in inflation hedges, such as investments based on gold, energy and other natural resources. 4. For your speculative funds, join Martin and aim to build $4,500 into $50,000 as bond prices fall and interest rates rise. In his strategy, relatively small interest-rate rises can produce disproportionately large profits. Meanwhile, your risk is strictly limited to the amount you invest (plus any commissions you pay your broker). Right now, if you join for one year, the second year is free. However, this unusual 2-for-1 offer expires on midnight this coming Sunday. So be sure to respond before then. Best wishes, Tony Sagami About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. © 2005 by Weiss Research, Inc. All rights reserved. |
Worst Trade Deficit Ever! Now What?
IF Treasury- bond prices were stable or rising overall, I wouldn’t be wasting your time — or mine — talking about this problem. 
In fact, the current downward slide in the price of the 5-year Treasury notes is even more serious because the price has plunged below its earlier lows made in March of this year. I feel this is a critical, landmark event that presages an accelerated decline in price and surge in yields.
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