Hopefully, the economy will soar next year.
I also hope everyone’s wishes and dreams come true — and that includes peace on earth and goodwill to all mankind. And, just to make 2011 an absolutely perfect year, let’s also pray that the prediction by Wall Street’s biggest pimp, Goldman Sachs, of another 20 percent rally in the stock market becomes reality.
Now that the wishing, hoping and holiday good cheer is out of the way, let’s get real.
There are many big problems that the financial world will be facing this coming year. The biggest may be the upward direction of interest rates, which will make all the other problems worse.
Right now, China is the epicenter of the interest rate problem. Just this past weekend, it raised its interest rates for the second time in as many months — a development that isn’t welcome in either the US or any of the other countries with weak economies.
But that’s not the only concern investors should have.
Just because the calendar is getting flipped to another year doesn’t mean all the world’s problems will go away. This isn’t like a baseball game where the scoreboard gets wiped clean after a bad performance and the team starts fresh.
Most people who follow the world economy don’t even know where to start when listing all the problems right now.
Is the home foreclosure problem still bigger than the mess in home equity loans?
Is the default rate on student loans more worrisome than the growing inability of local governments and even foreign countries to pay their debt?
Will China suddenly start pushing its full weight around?
Or is the US government’s deficit, which grows bigger with every stimulus plan, the only thing we should be worrying about right now because it could cause the dollar to become a trash currency?
There aren’t any easy or correct answers to any of these vexing questions.
But there is one overriding problem that stands out in my mind: the US economy simply hasn’t been doing what it should be doing.
The Federal Reserve, Congress and the President have thrown every conventional cure at the economy — and some voodoo ones — and it still isn’t performing well. Even if Wall Street’s pundits are correct in their revised view that the economy will grow by 3.5 percent next year, that is still a subpar performance.
Wall Street’s prediction for the economy has little chance of coming true. Why? Several reasons, but mostly because interest rates and commodity prices aren’t cooperating. Take a look at what’s happening with rates.
Since Oct. 7 — only slightly more than two months ago — the interest rate on 10-year government notes has gone from just 2.38 percent to around 3.35 percent. That’s a 41 percent increase!
And it’s not just that security.
The 30-year US bond, 3.51 percent back in August, is now 4.45 percent.
And those rates are likely to go higher because of China’s aggressiveness in fighting what it perceives as unacceptable inflation.
So, a company that might have been planning to borrow money long-term to do something — maybe build a facility or hire workers — suddenly finds itself with much higher costs. Its plans could easily change because of the higher cost of borrowing money.
And corporate profits, which are already a big concern for most executives, will also be hurt by the rising cost of borrowing.
Higher interest rates are, naturally, also a big problem for the housing market, which was the epicenter of all the recent disruptions and is crucial to the health of the economy and the banking industry.
Because of the rise in interest rates, borrowing money to buy a house has suddenly become considerably more expensive. The official average rate on a 30-year mortgage was just 3.58 percent back in October; it’s now 4.51 percent.
Soon the average conventional mortgage will be over 5 percent — which many will consider a psychologically troubling level. Some readers are already reporting rates over that level.
The bad news is already being reflected in the housing market.
The Mortgage Bankers Association said last week that mortgage applications plunged by 18.6 percent in the latest reporting period.
Rates started rising just before the last election. That was also when the Fed announced it would do more quantitative easing, which simply means increasing the quantity of money by printing more.
The first QE didn’t help the economy much last year when it was first put into use. So the latest round of money printing, QE2 as it is being called, is causing concern even before it gets off the ground.
QE did help the stock market — both in 2009 and this year. All the extra money being printed has caused what is referred to as a liquid ity bubble. All that means is that money — li quidity — will gravitate to the place where it can earn the most, even if that place happens to be a stock market that is rising dangerously past economic reality.
So what’s the investment forecast for 2011? Since bonds move in the opposite direction of interest rates, they will be super dangerous. Stocks? Another 20 percent gain? Perhaps, if the bubble continues. But what happens afterwards is what you really need to know.
(More on Thursday.)