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Six months ago, despite the consensus view that the United States was going broke, I recommended buying U.S. Treasury long bonds, then at $118 (U.S.).
Following the U.S. budget deal, the 30-year bonds are now at $136, or 15.3 per cent higher. Add 2.2 per cent for six months' coupon, and the return is 17.5 per cent. The S&P plunged 11 per cent during this period.
I don't say this to crow (well, maybe a little), but to note that the time has come to sell your long bonds into the bond-buying hysteria and start buying stocks.
Why? Because even as stock markets were plunging following Standard & Poor's downgrade of the United States' credit rating, the solution to the world's debt problem was already in motion.
No, not cost cutting by Congress. Lower oil prices.
The word's massive spending on oil is the only single expense big enough to move the dial on the total global economy – and the price of oil has begun to fall. This will likely continue, either because the West descends into a recession and uses less, or because the West forces oil producers to charge less. It's inevitable.
Think of the world as an indebted company. Based on my reading of the statistics, we can assume it has roughly $70-trillion in sales, on which it owes a staggering $100-trillion or so.
Now assume you're a turnaround specialist asked to fix this "company" so it doesn't go broke. What are your choices?
Barring hope and prayer, you must cut costs. And, as in every money-losing operation, there are only three kinds of costs: Employee wages, interest expenses, and the cost of materials and supplies.
If you choose mass unemployment, you'd be voted out of office (as in Spain), or face riots (Athens, London), or both. So that's out. And if you force banks to take big write-downs, you would merely be exporting unemployment to rich countries. So that's out too.
What's left, then? Telling suppliers to cut prices – and the West's biggest suppliers are Middle Eastern oil sellers.
Just how big? At the $100-a-barrel price of six months ago, the United States was spending more than $800-billion a year on oil, of which about 50 per cent was imported, according to the U.S. Energy Department. (To recall: U.S. GDP is about $15-trillion.) Europe spent a tad more. So if prices were, say, halved, the U.S. would save about $200-billion a year – more than the proposed cuts by Congress – while Europe would save about $600-billion.
In other words, deep oil price cuts would solve the West's problems.
Of course, it would also export austerity to the Middle East. But they don't vote here, do they?
With $100 oil, it was easy in February to see that the economy would stall and that made U.S. long bonds a buy. But with oil now in hovering just above $80, the West's economic burden is already hundreds of billions per year lighter – and is likely to get lighter still, as either the West enters a recession and uses less, or forces Eastern oil suppliers to charge less.
Whether obtained through weakness or through force, cheaper oil means a stronger Western economy, and this, on top of the S&P downgrade, would lead to higher bond yields and lower bond prices. So sell your U.S. long bonds at a nice profit and start buying stocks.
Why stocks? On a fundamental level, falling oil prices would enable the West to pay more of its debts and reduce bankruptcy fears. Cheaper oil would also unburden Western economies, raise corporate profits and boost tax receipts.
In addition, stocks are much cheaper now than they were just a month ago. Also, there is a growing possibility of a third round of quantitative easing, or monetary stimulus.
Since U.S. President Barack Obama wishes to be re-elected, a new round of stimulus may well be in the works. This new cash, if it does appear, must go somewhere. Its most likely destinations are either stocks or gold. Either way, the entrance of all that new money – and with it, the potential for inflation– is likely to spook bondholders.
So, sell your U.S. long bonds and start buying stocks. I say start, because the panic may not be completely over yet. But with oil prices falling, the world's turnaround has begun.
Special to The Globe and Mail