10 Years After: The State of America

BOSTON ( TheStreet) -- Economist Michael Pento says the U.S. is in much worse financial shape today than it was after Sept. 11, 2001.

But not for the same reasons -- for example, that the unemployment rate today is almost twice that of 10 years ago while consumer confidence has fallen by half.

Pento, president of Pento Portfolio Strategies in Parsippany, N.J., lays out what he says is a shocking statistic that has gone mostly unnoticed: The S&P 500 Index of the largest U.S. companies has risen 10% in the past decade but is down a whopping 85% if measured against gold. Investors, in other words, were burned by high valuations of stocks back in 2001, and since then have made up little ground while different asset classes such as gold and commodities have soared.
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That underperformance is what disturbs Pento, who was formerly the senior economist at investment manager Euro Pacific Capital in Westport, Conn., more than anything else he's seen. On Sept. 10, 2001, the S&P 500 closed at 1,092.54 and gold traded below $300 an ounce. A decade later, the S&P 500 is up to nearly 1,200 after fluctuating wildly between its highest point of 1,576.09 in October 2007 and a low of around 680 in March 2009. Gold, meanwhile, has been on an upward march to over $1,800 an ounce as investors seek safe havens for their money.

"That's a crash of epic proportions," Pento says. "Nothing good can ever come out of that one stat. That is one of the less promulgated facts because it's so daunting."

Pento also highlights the massive amount of debt on the balance sheets of both the federal government and individual households. In the fourth quarter of 2001, household debt was 73% of U.S. gross domestic product (GDP). Today, that figure is up to 89% of GDP. Federal debt, at about 55% of GDP 10 years ago, is now at nearly 100% of GDP.

"If you look at the national debt, household debt and the performance of equity averages against a real currency, it shows you how bad of a country we have been in the last 10 years," Pento says.

The story of how the U.S. got to this point, a decade later, is one of bubbles and bursts. The economic history of the U.S. since 9/11 has important ramifications for investors over the next decade.

Investors not in the market long enough would be wrong to think the terrorist attacks led to a weak performance by stocks. However, they forget the U.S. was in the midst of a painful recession before 9/11 thanks to the Internet bubble, which had been fueled by wild speculation and outsized valuations for companies that, in some cases, had no revenue.

"Business plans were written on the back of an envelope. Companies were floated and people were paying huge valuations," Rob McIver, co-portfolio manager of the Jensen Portfolio, recalls. "And now those companies are all gone." Thumbing through the 1999 edition of Mergent's Handbook of Internet Stocks yields profiles on companies such as spectacular blowups MCI Worldcom, Infospace.com, TheGlobe.com and CMGI.

The 9/11 attacks resulted in a catastrophic loss of life, and the impact exacerbated the decline in confidence among U.S. investors. The Federal Reserve on Sept. 17, 2001, cut the fed funds rate by 50 basis points to 3% due to the "heightened concerns and uncertainty created by the recent terrorist attacks and their potentially adverse effects on asset prices and the performance of the economy." By December, the central bank had slashed interest rates to 1.75% on the way to a 1% fed funds rate, where it remained from June 2003 until June 2004.

By trying to fend off a recession, though, it is argued that the Fed and then-Chairman Alan Greenspan instead fueled a completely new bubble as borrowers rushed to take advantage of low interest rates. Lewis Altfest, chief investment officer of Altfest Personal Wealth Management, says this is another problem investors have been forced to endure during 10 years of extremes, leaving the U.S. in worse shape now.

"We unwound the tech bubble over the past 10 years, but at the same time Alan Greenspan orchestrated a real-estate bubble," Altfest says. "Throughout all of that, there was a fundamental difficulty our country had with people spending too much money relative to income. Borrowing was fueling the difficulties we had and have now."

To some extent, the borrowing came about because people thought real estate would solve all of their difficulties. "They thought they were borrowing against an asset that couldn't go down," Altfest says. "Of course, that's never true and it wasn't true at that time."

"A lot of these people shouldn't have gotten car loans, never mind home loans," says Brian Peery, co-portfolio manager with Hennessy Funds, calling attention to one of the major issues that led to the financial collapse.

The housing bubble led to the crisis of late 2008 and early 2009. But instead of a much-needed rebalancing of household equity and debt, Americans have been encouraged to spend even more as the Federal Reserve has reduced interest rates to nearly zero. Last month, the Fed took the unprecedented step of pledging low interest rates until mid-2013 if needed, another troubling sign for those concerned about excessive borrowing.

"If a 1% fed funds rate for two years after 9/11 engendered an entire worldwide housing bubble, what will zero percent for four and a half years at a minimum bring us?" asks Pento. "How severe will the imbalances in the economy become? What will happen to savers? We will end up with four and a half years of discouraging savers."

Some professional investors now argue that the credit bubble continues to inflate in order to subsidize elevated living standards in the U.S., which will make the eventual unwind even more painful than what occurred three years ago.

"Instead of having standards of living adjusted down by markets over time, we've had this credit bubble created to sustain them," says James Dailey, portfolio manager with Team Financial Asset Management. "We need the markets to redirect capital. It'll be painful, but it's the most efficient way to do it. Instead, politicians and government draw it out over years and years, like in Japan in the 1990s. They're eradicating the middle class."

Another sign the U.S. is in worse shape now than a decade ago is the recent downgrade of U.S. debt by Standard & Poor's, the first time the country has ever lost the coveted triple-A rating. While S&P analysts pinned the downgrade on confidence in Washington, investors such as Dailey argue that no one has ever had confidence in Washington, and that the bigger problem has been debt and the misallocation of capital.

"That's how you end up with bubbles," Dailey says. "You have major parts of the economy where 7 million to 10 million who have jobs that no longer translate. We have a bifurcated economy where you have shortages in certain segments like software engineers and medicine and geologists, and yet you have a lot of out-of-work construction workers. The government has helped foment these problems."

Ten years on, the U.S. is now faced with an unemployment rate that has doubled, stagnant economic growth, and continued declines in housing prices with rising foreclosures. With new fears cropping up over sovereign debt in European countries like Greece, Spain and Portugal, there's little doubt the U.S. and investors are in a deeper hole now than they were a decade ago.

"We've become so arrogant as a nation that we believe we can repeal deficits and repeal recessions by decree," says Pento of Pento Portfolio Strategies. "When a nation becomes overleveraged, after decades of a buildup in credit, debt and asset prices, you need a period of deleveraging. That's the healing process."

But with public-sector debt up 90% in the past four years and interest rates near zero, it appears the U.S. has learned nothing. "It's more of the same medicine that nearly killed us," Pento says.

-- Written by Robert Holmes in Boston.

>To contact the writer of this article, click here: Robert Holmes.

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