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Billionaire David Tepper, one of the most
successful hedge fund managers in the world, attracted much attention in a
September 24th CNBC appearance by presenting such unrestrained optimism that
even the normally buoyant network hosts were somewhat surprised. In a
rare interview, Tepper argued that all asset
classes would go higher no matter if the US economy recovers or not (with the
possible exception of the US dollar). His faith is derived from the belief
that even if the US economy deteriorates and fails to raise markets through
organic growth, the Fed will certainly step in with enough liquidity to push
up stock and bond prices.
While Mr. Tepper may be correct in assuming
that the major averages could rally in nominal terms if the Fed undertakes another round of quantitative
easing, investors would still need to own the right assets to gain a real return on their portfolios. Like most professional investors,
Mr. Tepper is only concerned with nominal,
near-term performance.
Of course, in an environment of intractable inflation, most all asset
classes will rise- but they will not do so at the same rate. Inflation is
never evenly distributed throughout an economy and it affects various asset
classes in different ways. The best assets to own in order to obtain a
positive return after adjusting for inflation are commodities and
commodity-producing stocks, especially those that do not keep their retained
earnings in US dollars. The rarer the commodity, the more it will behave like
real money and maintain its value during a currency debasement. Gold
increases in price more than semi-precious metals because it has less
capability of having its supply increased by discretion.
But the point missed by Mr. Tepper (and
those at the central bank with whom he has placed his faith) is that the very
inflation that will bolster stock prices will also destroy the underlying US
economy. The Fed currently has the hubris to believe that it has the ability
to print the US into prosperity and that it will always be able to keep
long-term interest rates from rising. It can't. The Fed can manipulate the
yield curve lower through quantitative easing, at least initially; but the
more bonds Bernanke & Co. purchase, the more quickly the rate of
inflation will increase.
Right now, the yield on the 12-month T-bill is .25% and the rate of
consumer inflation as purported by the government is about 1%. That means
even when using a tortured metric like the CPI (25% of which is owners'
equivalent rent), real interest rates are still negative. A better metric
would be to use the price of gold, which has increased 30% YoY. Or how about using the CRB Index, a broad measure of
commodity prices? It's gone up 13% over the past year. If you adjust nominal
interest rates by using these measures, or even the dollar itself, which has
lost 11% since June, rates are already profoundly negative.
So, the question is: how much more negative will the Fed be able to send
interest rates before the bond vigilantes wake up from their suspended
animation? After all, can anyone expect fixed-income investors to continue to
accept plummeting real interest rates for very much longer? Once domestic
bond investors regain consciousness-and they will most likely do so in
concert with foreign holders of US debt and currency-a debt and dollar crisis
will emerge. Then, the only buyer of US Treasury debt will be the Federal
Reserve. An economy can't persist for very long by buying its own debt with
printed money. The result will be a crumbling currency and soaring interest
rates, especially on the long end of the yield curve. When rates rise despite
the Fed's efforts to keep them down, that's game over for the
"recovery."
The final kick in the head is that the depression the Fed has been
trying desperately to avoid will still occur- except that it will be
accompanied by runaway inflation and rapidly increasing interest rates
instead of falling prices and reduced debt expense. Those investors like
David Tepper who choose to believe they can keep up
with inflation simply by investing in "everything" will be shocked
to discover how little their nominally high returns are actually able to buy.
Michael Pento
Senior
Market Strategist
Delta Global Advisors, Inc.
Delta Global Advisors : 19051 Goldenwest,
#106-116 Huntington Beach, CA 92648 Phone: 800-485-1220 Fax: 800-485-1225
A 15-year industry veteran whose career began as a
trader on the floor of the New York Stock Exchange, Michael Pento recently served as a Vice President of Investments
for GunnAllen Financial. Previously, he
managed individual portfolios as a Vice President for First Montauk
Securities, where he focused on options management and advanced yield-enhancing
strategies to increase portfolio returns. He is also a published
economic theorist in the Austrian school of economic theory.
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