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SPX Heading to 1422

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The fuse is burning and we see the SPX decisively breaking out above its April highs of 1420-1422. That potentially brings into view targets above 1500.

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From Money Angels by Andrew Tobias:

There was a king who held a chess tournament among the peasants and asked the winner what he wanted as his prize. The peasant, in apparent humility, asked only that a single kernel of wheat be placed for him on the first square of his chessboard, two kernels on the second, four on the third – and so forth. The king fell for it and had to import grain from Argentina for the next 700 years. Eighteen and a half million trillion kernels, or enough, if each kernel is a quarter-inch long (which it may not be; I've never seen wheat in its pre-English-muffin form), to stretch to the sun and back 391,320 times. That was nothing more than one kernel's compounding at 100 percent per square for 64 squares.

When compound interest works in your favor, it is a blessing. But when it works against you, it is a curse. Just ask Washington Mutual (WAMUQ), or General Motors (GM).

More recently ask Greece, whose "debt chickens" have come home to roost. For example, Greece's 10-year sovereign note sported a yield of around 5% back in 2010. Subsequently, it soared to more than 30% earlier this year, and currently changes hands around 24%. When yields are double-digits the power of compound interest working against the borrower is awesome. Consider the following example from the same book by Andrew Tobias illustrating the term of interest and return on interest:
Say you borrowed $1,000 from a friend and paid it back at the rate of $100 a month for a year. What rate of interest would that be? A lot of bright people will answer 20 percent. After all, you borrowed $1,000 and paid back $1,200, so what else could it be? Forty percent? No [it's] more. If you'd had use of the full $1,000 for a year, then $200 would, indeed, have constituted 20 percent interest. But you had full use of it for only the first month, at the end of which you began paying it back. By the end of the tenth month, far from having use of $1,000, you no longer had use of ANY of the money. So you were paying $200 in the last two months of the year for the right to have used an average of $550 for each of the first ten [months]. That comes to a bit more than a 41.25 percent effective rate of interest. (Trust me).

I revisit this compound interest theme this morning because the recent rise in interest rates has been one of the most important events that have occurred over the past few weeks. The rate rise is important because this week the US Debt Clock will cross above $16 trillion (excluding off balance sheet items), and if we stay on the same debt course by 2015 the US will have accumulated $20 trillion in debt. Accordingly, the increase in the 10-year T-note's yield, from 1.38% on July 24 to last week's high of 1.86%, is significant. Consider this: By 2015, if our debt is at $20 trillion, an aggregate yield on that debt of 2.5% means the cost of servicing the debt is roughly $500 billion per year. At a yield of 5% our debt service cost would be $1 trillion; and at 10%, the yearly debt service would be $2 trillion, or nearly all of the $2.3 trillion our government receives in revenues!

Unsurprisingly, most of the folks I talk to inside the DC Beltway realize we are on an unsustainable path; and that's why I think no matter who is elected in November my sense is we are going to get smarter policy makers, more practical policy, and more productivity out of government. Currently few believe this is possible, but if you look at what's happening at the grassroots level, there are a lot of good things happening on both the "left" and the "right." One entity that appears to embrace this more positive scenario is Mr. Market.

Indeed, while there are some pundits commenting on the recent increase in interest rates, there is NOBODY expounding on the fact that the S&P 500 Total Return Index is probing new all-time highs (see chart below).


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No positions in stocks mentioned.
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