Stock Market Built on Seismic Fault

Pay now or pay later. But pay you must...

WHAT issue can stocks no longer ignore? asks Brian Maher at The Daily Reckoning.

Ten-year Treasury notes.

The 10-year Treasury note yielded 3.92% at year's onset.

Last week the 10-year Treasury note yielded 4.55% – a 63-basis point leap.

Jim Rickards labels such a bond yield effervescence an "earthquake". And the seismometers on Wall Street are reporting tectonic activity. Bloomberg's Jan-Patrick Barnert:

"While stocks were mostly ignoring a rise in bond yields since mid-May it seems that...stocks can't ignore the issue any longer."

Adds Bloomberg: "Higher yields are starting to hit stocks."

For years the stock market and the economy rose upon a San Andreas Fault of artificially low interest rates.

Artificially low rates have kept the $100 trillion edifice of public and private debt standing.

This architectural atrocity stretches thousands of feet into the sky – yet only inches into the earth.

That is, it has been all high-rise and no foundation. It has been all height and no depth.

The thing risks a great heaping down as rates shove higher.

This is the peril of erecting misproportioned structures upon a deeply unstable fault line.

And vast tectonic energies, vast potential energies, are mounting and mounting.

Reports Fox Business:

"New research published by Baringa, a global consultancy firm, found that companies that refinance between this year and 2030 will pay an additional $381 billion in interest costs due to elevated borrowing rates. This amounts to the largest single increase in debt-related costs and the highest cumulative interest payment total ever faced by US companies.

"The largest expense is expected to occur in 2024, with more than $3 trillion in loans and bonds set to mature this year. Companies refinancing that debt will likely pay $76 billion more in interest this year than they did under lower interest rates, according to Baringa, which analyzed FactSet data."

In conclusion:

"It's tempting to look at plateauing interest rates and conclude that the worst is behind us, but that's simply not true," said Cindra Maharaj, partner in Baringa's financial services practice. "In fact, US businesses and the wider economy are just beginning to experience the painful effects of a serious hangover from the rapid escalation in interest rates that will last for several years to come."

The United States government confronts an identical fix.

The Congressional Budget Office projects 2025 net interest expenses will scale $951 billion.

From 2025-2034 the same Congressional Budget Office divines annual $1.2 trillion net interest expenses...for a combined $12.4 trillion.

We add that the Congressional Budget Office forecasts no recession. It further forecasts habitually expanding tax receipts.

What if recession comes hammering down? What if tax receipts do not expand in the forecast fashion?

Then net interest expenses will bulge greater yet.

And the central difficulty multiplies – deeper into the pit goes the government of the United States.

That is, deeper into the pit go the citizens this preposterous organization purports to serve.

For they are thrown upon the hook. The burden of payment is thrust upon them.

As we have argued before: Government lacks all resources.

Before government can ladle out one meager Dollar for guns, for butter, for bread, for circuses...it must first pluck it up from private pockets – directly or indirectly.

That is, directly through taxes or indirectly through credit – borrowing.

That is, through taxes or taxes.

The borrowed Dollar must be repaid...with interest into the bargain.

Thus the Dollar borrowed is merely a delayed plucking, a plucking at one remove.

It is a plucking nonetheless. It represents a future plucking of the taxpayer's pocket.

It is in one sense a greater plucking owing to the interest. It is he who services the interest. It is he who absorbs the fleecing.

And we hazard he is in for an extended fleecing. We do not believe elevated rates are a transience.

Michael Hartnett is Bank of America's chief investment strategist. From whom:

"The lower inflation of the last 40 years that sent interest rates down and stock market valuations higher has reached a turning point. We believe we are at a secular turning point for both inflation and interest rates.

"We believe 2020 likely marked a secular low point for inflation and interest rates...due to a reversal of deflationary secular factors, fiscal excess and an explosive cyclical reopening of the global economy creating excess demand for goods, services and labor."

And if you invest money in the stock market? You confront a vastly extended lean season.

Market history has witnessed eight major cycles dating to 1871. Investors grabbed the greatest gains – nearly all of them – in four cycles of the eight.

Investors handed over their gains in the others. The silent thief of inflation pickpocketed them.

Importantly: The bulking majority of market gains across these cycles were harvested during disinflationary cycles – not inflationary cycles.

What if Hartnett is correct? What if the 40-year cycle of declining inflation and declining interest rates is ending?

It would suggest rough going for stocks during the coming years...as the cycle swings from disinflation...to inflation.

At present valuations, stocks could shed 50% or more of last decade's gains.

By some estimates, your odds of losing money in the stock market approach 100% – odds that make the bravest fellow quail.

What if we train our binoculars on the farthest horizon...20 years out?

Michael Carr instructs technical analysis at New York Institute of Finance. Says he:

"Starting from this level, stocks are likely to disappoint over the next 20 years."

Twenty years? That is correct:

"When the P/E ratio is near all-time highs, as it is now, the S&P 500 delivers annual returns averaging about 5% over the next 20 years. When the P/E ratio is near all-time lows, returns are about three times higher, averaging 15.4% a year over the next 20 years."

Yet as we are fond to say: Climate is what you can expect. Weather is what you actually get.

Even the harshest bear market has its joys, as even the harshest winter has its thaws.

We expect not a fantastic tempest but a protracted malaise – a long season of dreary drizzle, of false starts and false dawns.

This time is different, say Wall Street's drummers. It always is.

Yet if a hangover exists in direct proportion to the binge that produced it...investors may be down for the following decade...or two...