This blog post originally appeared on RealMoney Silver on Sept. 3 at 8:27 a.m. EDT.
At current yields, bonds represent certificates of confiscation, and bond holders face the likelihood of large capital losses.
I believe that, on a risk/reward basis, shorting fixed income is among the most attractive investment strategies in the year(s) ahead.
Bearish economic concerns are overblown. There will be no double-dip. Most indicators point toward a domestic economic growth rate that is moderating but also likely to be sustained.
The 2.60% yield on the 10-year U.S. note is discounting a double-dip. Over the course of the past 60 years, the 10-year note has yielded 365 basis points more than GDP growth. In other words, the fixed-income market is now discounting an unlikely 1% drop in GDP (2.60% less 3.65%).
Over the same time frame, the yield on the 10-year U.S. note has averaged about 300 basis points more than the inflation rate. While zero-interest-rate policy argues for a somewhat lower relationship, since the implied inflation rate in TIPS is about 1.6% now, this would imply that the yield on the 10-year U.S. note should be closer to 4.60%, or 200 basis points above the current reading.
Numerous cyclical components of the economy (inventories, autos, housing) are at very low levels relative to GDP and substantially below their long-term trendline relative to GDP. This limits the likelihood of a double-dip, and in the fullness of time, a mean-reversion could add several trillion dollars against a $15.0 trillion GDP.
Housing, in particular, stands ready for a gradual expansion that could be sustained for many years. Affordability is at a multi-decade high, mortgage rates are at generational lows, the value of home ownership vs. renting is back to mid 1990s levels, payroll growth should soon expand, and new-home production has fallen well below household formations for over two years. (Supportive of a positive forward-looking view was the 5.2% increase in pending-home sales in July reported yesterday.)
While business indecision associated with tax and regulatory policy has led to disappointing payroll growth, most indicators (corporate profit growth, productivity, risk/credit metrics, average weekly hours, etc.) continue to point to an improving employment picture in 2011. More typical payroll growth could come sooner than many believe if the logjam of tax and regulatory is somehow relieved.
Focused fiscal and/or tax policy geared toward job growth could unleash confidence and jump-start domestic economic growth, raising the probability of higher interest rates.
American consumers are in better shape than is generally expected, as they are deleveraging their balance sheets and rebuilding savings faster than generally recognized. While debt/income is elevated, two key metrics -- household debt service as a percentage of disposable personal income is projected to drop from 120% in 2008 to an estimated 72% by 2012 (back to mid 1990s levels), and household debt as a percentage of disposable personal income is forecasted to decline from 124% to 107% -- indicate that the deleveraging timetable is nearly a year ahead of schedule.
Looking forward, the plunge in mortgage rates will likely push debt service still lower, and a refi boom could put money in consumers' pocketbooks. So, the headwind to consumer spending from deleveraging seems to be becoming a smaller risk to the economic outlook, as consumers now can spend more of their income.
Doug Kass writes daily for
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At the time of publication, Kass and/or his funds were long TBT, although holdings can change at any time.
Doug Kass is the general partner Seabreeze Partners Long/Short LP and Seabreeze Partners Long/Short Offshore LP. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.