By Michael Pento

The similarities between the subprime mortgage crisis and that of the coming collapse of the U.S. bond market are uncanny. In fact, Mark Twain may have had the U.S. debt market and the previous debt-fueled real estate crisis in mind when he said that “History does not repeat itself–but it does rhyme.”

The housing and credit crisis first became evident to most in 2007 with the distress in the subprime mortgage market. The foundation for the housing bubble was low interest rates, which were provided by the Fed, and passed along to consumers via commercial banks and the shadow banking system. Those low “teaser rates” from the Fed compelled consumers to take on too much debt and for banks to become overleveraged. Excessive lending in the real estate sector of the economy caused home prices to skyrocket out of reach of most consumers. Home prices subsequently fell and the assets on banks’ balance sheets tumbled in value. The result was the biggest economic contraction since the Great Depression.

Similarly, rock bottom interest rates provided by the Fed and from foreign central banks recycling our trade deficit are misleading the government into believing it can take on a tremendous amount of debt by spending significantly more money than it collects in revenue. Those low rates have also duped the Treasury into believing it can sell a virtual unlimited amount of debt without ever incurring a substantial increase in debt service expense. Of course, this is not unlike homeowners who took on onerous mortgage payments, believing home prices would always increase.

And just like those homeowners who took on adjustable rate loans, our Treasury has set itself up for a bout with intractable mortgage rate resets. Interest rates are currently at historic lows, but instead of choosing to take advantage of those rates by locking them in for decades, the U.S. Treasury has chosen to follow the lead of subprime borrowers. The government should be taking on the equivalent of a thirty year fixed-rate mortgage by issuing only 30 year bonds. However, they have chosen the path of what amounts to a short term adjustable rate mortgage by moving their debt duration to the short end of the yield curve.

Today the Treasury has an average maturity on its debt of just about 5 years. Compare that with the U.K. which is about 14 years and even to Greece which is about 8 years in duration. That means the U.S. must roll over its debt much more frequently and is much more susceptible to rising rates. The only logical explanation for this practice is that the U.S. doesn’t feel it can issue long term debt and still afford to service its interest rate expenses.

Another similarity between the housing and bond market bubbles is that the housing market of circa 2006 and the U.S. bond market of today contain all three elements of a classic asset bubble; massive oversupply, an unsustainably high price level and over-ownership of the asset class in question. In the early part of the last decade, home builders began to increase construction volume to twice the intrinsic demand for home ownership. Home price to income ratios eventually reached unsustainable levels. And levels of home ownership reached a record high percentage of the population.

Likewise, the U.S. Treasury is dramatically increasing the supply of debt each year to fund our $1 trillion deficits. The public has plowed their savings into the U.S. debt market as commercial bank holdings of Treasuries have reached an all-time high. And bond prices have soared, pushing the yield on the 10 year note to 3.6%, which is less than half the average yield of 7.3% going back to 1969.

Therefore, all the elements of a bubble in the bond market are in place, just as they were for the real estate market in the middle of the last decade. And now, if we do not aggressively cut spending on the federal level, the bond market may be ready to enter a multi-decade bear market in prices. The trigger for this secular move higher in yields will be the resurgence of inflation and the overwhelming effect supply has on bond prices.

However, a temporary reprieve from significantly higher yields has been given courtesy of Europe. Investors are fleeing Greek debt and the Euro currency in favor of the U.S. dollar and our bond market. But this is a temporary phenomenon and in no way bails out America from its own fiscal transgressions. In just a few years our publically traded debt will reach nearly $15 trillion. If interest rates just rise to their historic averages, the interest on our debt (depending on the level of economic growth and tax receipts) will absorb anywhere from 30-50% of total Federal revenue. If we indeed reach that point, massive monetization of the debt may be deployed by the Fed in a vain effort to keep rates from spiraling out of control.

One last similarity between the two bubbles is that the prevailing consensus of not too long ago was that home prices could never decline on a national level. Today, we are being told that the U.S. dollar will always be the world’s reserve currency and that Treasuries will always be viewed as a safe haven by global investors. Remember how those in Washington and on Wall St. also assured investors that the subprime mortgage problem was well contained and would not bring down the housing market-much less the entire global financial system? Well, regardless of what those same people are saying now, these record low yields on U.S. Treasuries are unsustainable and cannot last given our massive $13 trillion national debt, $108 trillion in unfunded liabilities and the record-high $2.3 trillion Fed balance sheet.

Astute investors should prepare now for the likelihood of much higher interest rates in the not too distant future.

Michael Pento is the Senior Market Strategist for Delta Global Advisors

In the seven months since it recorded its panic low close of 676, the S&P 500 has risen over 60%, and stands substantially higher than it did a year ago.No one seems to want to believe it.

Set aside for a moment the economic backdrop of this remarkable and even historic recovery (which, like the crash that preceded it, has no precedent since the 1930s). That discussion will get us nowhere, since no one can agree on what the economic backdrop is, much less on an economic forecast. Concentrate, if you will, on equities themselves, on the fortunes of the companies they represent…and on the rather odd response of investors to this marvelous upsurge in equity prices.

It would take a heap of skepticism to regard a 60% rise in stock prices as anything other than a new bull market, however one defines that term. And such skepticism certainly appears to be in bounteous supply. Consider cash, for example.

It will be forever remarked upon by future market historians (who will shake their heads in wonder that anyone could have missed this signal) that for several months surrounding the panic lows, the sum of cash in bank savings accounts and money market funds exceeded the total market capitalization of the Wilshire 5000. That is, Americans could have reached out and, using only their cash on hand, bought the American equity market in its entirety. This, however, they declined to do, as they had become convinced that the world was coming to an end.

When the world once again stubbornly refused to end, and instead the buds of spring returned to its trees, this wall of cash began to crumble. Indeed, something like $400 billion dollars has exited money market funds over these seven months. Surely this one-time surge is behind the equity market’s wild runup, say the skeptics; surely cash has shot its bolt.

This argument is extremely compelling, right up until you discover where the money actually went. Because it seems largely to have gone not into equities at all, but into bonds. Indeed, the well-regarded research firm Strategas recently noted that over the last three months eleven dollars in net inflows have gone into bond funds for every net dollar into equity funds.

This just makes sense. You may conclude—as apparently most people have—that the world is not ending without going so far as to actually become, in any real sense, optimistic. You just think the radiation levels have declined sufficiently that you can get out of near-zero-yielding cash equivalents, and inch your way cautiously up the yield curve. But that’s still money which hasn’t entered the equity market…yet.

Nor—and in the long run this may turn out to be an even more important point—is the individual investor’s cash the only cash around. Far from it. For as JPMorgan Global Wealth Management’s chief investment officer Michael Cembalest recently noted, “Cash and liquid securities on corporate balance sheets are at the highest levels since 1951.”

He went on to say that another measure of corporate cash flow net of capital spending and inventories has only been higher on a few occasions in the last half century. The recent spate of merger and acquisition activity—Abbott/Solvay, Unilever/Sara Lee, Dell/Perot Systems—may be the opening round in a major strategic deployment of this corporate cash hoard. For it is too easily overlooked that, even as the financial sector went into the recent crisis hideously overleveraged, the rest of corporate America (ex-autos) was keeping its powder bone dry.

And, as economic activity cratered, companies moved aggressively to protect those assets, through production shutdowns, inventory runoffs, and (most notably) layoffs. Mr. Cembalest at JPMorgan estimates that for every dollar of reduced revenue in the recent cataclysm, S&P 500 companies cut expenses by 88 cents. That’s precisely where the huge spike in unemployment came from.

But it’s also why just about every earnings report you’ve heard so far in the third quarter has been ritually prefaced with the phrase “better than expected.” It’s operating leverage, and we may see a lot more of it as production recovers. So much so that the emerging consensus earnings estimate for the S&P of $75 in 2010 looks a bit less far-fetched with each passing day—and each earnings report.

And still, no one seems to want to believe it. This is perfectly understandable if one panicked out of the market on the way down, and is still out. With the S&P 500 at 1100, everybody who fled the market since the first week in October of last year—when the $700 billion bailout bill finally passed, and global markets crashed to new lows in celebration—is under water. Can’t blame them for wanting to believe that this recovery is unsustainable: it’s about the only hope they’ve got left.

But of late one has begun to hear of people who stayed the course, suffered through the worst decline in our lifetimes, participated in the greatest rally—and now want to fly into cash and gold. Dow 10,000 has become for these people, in some mysterious way, the financial equivalent of the sound barrier. And one is hearing those stories a lot.

It is axiomatic, in Wall Street lore, that a bull market climbs a wall of worry. But this bull market is something special. It’s climbing a wall of sheer, systematic, single-minded and impenetrable disbelief.

Which, for some of us, becomes just one more powerful reason to believe.

© 2009 Nick Murray. All rights reserved. Used by permission.