A year ago, I provided my outlook for 2011, focusing on housing, monetary policy, oil, gold, Treasury yields and mortgage rates. Everything occurred as anticipated with the exception of gold. I had prognosticated that gold would fall below $1,000 per ounce.
The other highlights were that housing would continue to contract, deflationary pressures would be greater than inflationary pressures, oil would remain in the $100 range, 30-year fixed-rate mortgages would fall below 4%, and the Federal Reserve would implement another round of quantitative easing.
Now, on 2012...
The macro issues shaping up for 2012 are again deflation, housing, Treasury yields, mortgage rates, monetary policy and oil.
Although deflation continues to overwhelm inflationary pressures in the U.S. economy in aggregate, there is growing evidence of price inflation in commodities, especially oil. Oil prices are rising faster than global GDP, or even Chinese GDP. Further, oil prices are rising even as the rate of increase in demand is decreasing as the European Union's financial and economic crisis is beginning to affect other markets.
This indicates that oil prices, a proxy for commodities in general, are now more reflective of speculation and asset-parking than of expectations for an increase in global economic activity and thus demand for oil.
When asset-parking becomes institutionalized or secular, long-term rather than short-term or cyclical, it indicates that two things are happening: Monetary stimulus is not getting transmitted to the real economy, and investors, rather than just speculators, do not expect that to change anytime soon.
In such an environment, monetary policy is rendered powerless as a tool for causing an increase in economic activity.
That does not mean that it won't continue, however. The Federal Reserve will be forced to continue with more stimulus and an expansion of its balance sheet in order to allow the banks to continue to absorb losses on their real-estate-related assets. As this occurs, the 10-year Treasury yield will be pulled to even lower yields. A 10-year Treasury yield of 1% and a 30-year fixed-rate mortgage of 3% are possible before year-end 2012.
This same process will play out in Europe, as the European Central Bank must step in with more stimulus. That will result in the long-end yields for Japan, Germany and the U.S. all converging at about 1% for the 10-year sovereigns and 2% for the 30-year sovereigns. As this process accelerates throughout the year, the yen, euro and U.S. dollar will depreciate simultaneously with little movement against each other. This process will cause volatility to increase in all asset classes as speculators and investors waffle back and forth between concerns over a depreciating currency and slowing economic activity.
Ultimately, concerns over slowing economic activity will swamp currency concerns and will be reflected in lower spot prices for equities and commodities and lower yields for sovereign and investment-grade debt.
Slowing economic activity also means a decline in corporate earnings and a resulting commensurate decline in stock prices. The decline of as much as 50% for the S&P 500 is reasonable. This process should also cause oil prices to decline by an equal amount; back to around $50-$60 per barrel.
I'll address gold briefly again. I anticipated that gold would decline to below $1,000 in 2011 from the roughly $1,400 level at which it opened the year. It of course did the exact opposite, marching steadily to $1,900 this past summer.
So I was as wrong as possible on gold for 2011. I am, however, sticking with a sub-$1,000 gold price for 2012, as I believe it will be dragged down by the flight to liquidity that affects the rest of the asset classes.
Lastly, all of these issues combined will signal the final stage of the economic contraction in housing, consumption and the general private sector that began in 2007. And that will set the stage for secular growth in the economy and establishment of the virtuous cycle of optimism, consumption, bank lending, economic activity and job creation in 2013.
But we have to get past 2012 first, and I think it's going to be brutal.