This blog post originally appeared on RealMoney Silver on Jan. 7 at 8:47 a.m. EST.Last night was another fun segment with the "Fast Money" gang. During my appearance, I believe that cash will be king over the next few months. I expressed four principal concerns that represent challenges to the smooth and self-sustaining economic recovery upon which a lot of the recent market enthusiasm has been based.
Concern No. 1: Fiscal Policy and ImbalancesThere are consequences to our profligate spending and to our monetary and fiscal policies. That has been the message of the rising price of gold over the past several years. As we move closer to the 2012 election, the risk is that neither the Democrats nor Republicans have the political will to move on reducing the deficit. I fully expect partisanship to replace what now appears to be a move to the center by the Obama administration and its opponents. Our fiscal imbalances at the local, state and federal levels are out of control. Aggregate federal debt is now above 90% of GDP now. In This Time Is Different, authors Carmen Reinhart and Kenneth Rogoff point out that once you get to the 85%-90% threshold of excessive debt/GDP levels, there is a secular erosion in country growth rates.
Concern No. 2: Structural Unemployment"Fast Money" panelist Zach Karabell wrote a great column in Time Magazine yesterday, " Where the Jobs Aren't: Grappling With Structural Unemployment," which fits in precisely with this concern. While the job picture has brightened, the large roster of unemployed is structural and will remain with us in the new year, owing to a bunch of "mega trends" such as rising globalization, gains in technology and temporary employment becoming a permanent feature to the jobs market. As Zach writes, "these structural issues will not go away simply because the Fed pumps more money into the system or Washington spends more in the form of tax cuts or stimulus."
Concern No. 3: The Rapid Rise in Interest RatesThe risk that interest rates continue their rapid rate of ascent has been one of my most common ursine themes over the past several months (I have called shorting bonds " the trade of the decade.") Not only do higher rates compete with equities but they represent a serious challenge to the already weak residential real estate market. Home prices have not bottomed. Refinancings are already evaporating, and the S&P/Case-Shiller Home Prices Index has turned down in the last three months (and will likely worsen as foreclosures delayed by the robo-signing scandals come back into the marketplace for sale).
Concern No. 4: ScrewflationThe struggling middle class faces wage deflation and rising costs of living -- it is being screwed. Moreover, 10 years of flat stock prices and three years of declining home prices provide a weak foundation for the U.S. consumer, an important contributor to economic growth. We don't have to look much past Target's ( TGT) weak December same-store sales to see that corporations will fall victim to screwflation. From my perch, Target's poor sales are not a one-off event. If I am correct that a relatively large component of the October-November improvement in retail sales was simply recession fatigue, personal consumption expenditures could flatten out in the months ahead. ("Fast Money's" Cortes was spot on in his halftime remarks on retail.) "Fast Money's" Stephen Weiss argued against my view, pointing to rising productivity and wages and less political partisanship. He is willing to write off the housing problem and believes that the U.S. economic picture is improving. Stephen believes that investors are tired of negative headlines, and he dismissed my rate-rise argument on the basis that it reflected improved economic growth. I asked Stephen whether he thought P/E multiples would expand in 2011? He said yes. I responded that valuations could contract somewhat (a variant view) this year based on:
- a deceleration in the rate of earnings growth;
- rising inflation and interest rates;
- an uneven and lumpy economic setting would produce lower and more volatile than consensus corporate profits; and
- the continued tail risk in credit from the last cycle (e.g., the difference between the yields on Spanish and German 10-year bond yields indicates that the eurozone crisis remains intense).