March 1, 2024
By Steve Blumenthal
“When we talk about the bond vigilantes calling the government to task, we’re talking about this. The government needs to fund itself, and the task is getting more challenging.”
– Steve Blumenthal, On My Radar Feb 23, 2024
I want to reiterate a point made last week—the elephant in the room: We have more debt, spending deficits, and entitlement obligations than we have money for. The math doesn’t add up.
Jeffrey Gundlach summed up the problem nicely in the latest DoubleLine Round Table Prime discussion on macroeconomics, too. If we keep the current tax system as it is, 50% of all tax receipts will go to cover the interest expense on US Government debt. 50%!
Why? Because the government financed debt at low interest rates, and they now have to refinance it at higher interest rates.
However, the 50% number also assumes there won’t be a recession. As you know, I believe there will be one. In the last three recessions, the deficit went up 9% of GDP on average. Today, the deficit is 6.5% of GDP. Let’s say it increases to between 8% and 12%, depending on how optimistic or pessimistic you want to be.
Judging by what happened in the last three recessions, we could be looking at an interesting scenario. Follow this hypothetical with me: If interest rates stay between 4% and 5%, where they are today, or go up to 6%, the deficit will increase from 6.5% of GDP to 8% of GDP. Let’s say it stays there for five years. Assuming the current tax system holds, we’d see more than 50% of tax receipts going toward the interest-expense portion of the budget. (Source: DoubleLine Capital)
Now, let’s take a more draconian view and say that interest rates go up to 9%. In that case, with the current tax system, 100% of tax receipts would go toward covering the interest expense. We can all agree this is not possible. It simply can’t be done.
Gundlach said everybody should prepare for this to happen in five years. Nobody is prepared for it now.
He added, “We’re in this scheme where giving out money seems to be the answer to everything,” and that it seems we’re going to continue doing that. Sadly, I agree.
Gundlach concluded his portion of the discussion by saying that he’s been in the investment game for over 40 years, and those like him who’ve been around that long think they know how things work in terms of economic relationships. But during that 40-year period, interest rates mostly fell. So, that’s the paradigm of our understanding of the markets. Broadly speaking, he said, “If you had a problem, you were able to refinance at lower interest rates. Over that time period, we had multiple recessions, and interest rates went down in recession, and people, companies, and government could refinance at ever lower interest rates.”
He noted Mark Twain once said, “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.” Maybe a lot of our ideas about macroeconomics are informed only by falling interest rates. But interest rates aren’t falling anymore. So, maybe what we think we know for sure just ain’t so.
Our funding needs are enormous. So, it’s possible that in the next recession, interest rates could go up. What if we actually default on our debts in the next recession? What if higher interest rates don’t allow for refinancing? Who’s to say we couldn’t see a much higher default and much lower recovery rates? Time will tell.
We’re now experiencing the consequences of a foolishly long period of zero interest rates. Those low rates allowed us to borrow all this money—too much—and now, the debt is being refinanced at much higher interest rates, which we’re not prepared to pay. It’s a problem we will absolutely have to deal with.
Looking at the Congressional Budget Office’s projections, the trustees of the Medicaid system acknowledge that the system will run out of money by 2030. Similarly, the Social Security Administration’s trustees acknowledge they’ll run out in 2032. And these are based on optimistic assumptions. The CBO’s projections assume that interest rates will be at 3%—but they’re already at 4% to 5%. They assume the budget deficit will be about 3% or 4%—but it’s 6.5% today. They also assume that GDP growth will be about 4% on a nominal basis and about 2% on a real basis forever. And they assume that there will never be a recession. These are optimistic and unlikely assumptions. (Source: DoubleLine Capital)
We can almost guarantee that we will have another recession by 2028 (Gundlach believes we’ll have one before 2025). What that means is Medicaid will run out of money before 2030, and Social Security will run out before 2032. Whenever it happens, it’s going to be a huge moment. (Source: DoubleLine Capital)
Talk about the “Great Reset.” You can begin to get a sense of the enormity of restructuring needed.
Here we are in 2024. We have $213 trillion of unfunded liabilities and only $188 trillion in assets, according to usdebtclock.org. Our liabilities exceed our assets. We’re what you call bankrupt. We have a presidential election in just eight months, and people are starting to worry about the deficit. By the 2028 election, Gundlach believes the deficit will be the only factor on people’s minds. We need to restructure our liabilities. After that, it could lead to a period of prosperity. But between here and there lay a great valley. Keep your risk mindset in place.
I shared the following X tweet with you last week. It is worth another look.
Grab your coffee and find your favorite chair. I had the absolute pleasure to interview Peter Boockvar and Barry Habib this week for the podcast. We talk about the commercial real estate space, the timing of debt coming due, and implications for the system. You’ll find highlights from our conversation, including some great charts from Barry and links to replay it on YouTube and Spotify.
Additionally, Ray Dalio is out with a new post this week titled, “Are We in a Stock Market Bubble?” Surprisingly, Ray says no.
On My Radar:
- Peter Boockvar – Barry Habib – Steve Blumenthal
- Understanding Long-short Investment Strategies
- Are We In A Stock Market Bubble? By Ray Dalio
- Random Tweet’s
- Personal Note: Park City – WallachBeth 2024 Winter Symposium
- Trade Signals: Weekly Update, February 28, 2024
See Important Disclosures at the bottom of this page. Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.
Peter Boockvar – Barry Habib – Steve Blumenthal
The drumbeat of stress in the CRE market is quickening. Keep the following CRE Loan Maturity Schedule in mind as you watch or listen to our discussion:
Source: @Lizannsounders
Here are a few bullet-point highlights:
- “I thought there was about $500 billion of commercial real estate debt due this year that needed to be refinanced, according to the Mortgage Bankers Association. That ended up being way off, as the MBA yesterday revised that number to $929 billion…” Peter Boockvar via @GoldSeabrid
- On last night’s earnings call, Ian Siegel, the CEO of ZipRecruiter, said, “While reported job growth numbers have remained strong, this growth has been unusually concentrated. Nearly 80% of all jobs added in 2023 have been in just three sectors: healthcare, government, and leisure and Other industries, such as transportation and warehousing and information, remain below levels seen in early 2022, prior to the most recent hiring slowdown.” Source: @pboockvar
- This higher-for-longer interest period is real, and it’s going to stay with us for a while.
- QE lifted stock prices; QT in 2018 hurt stock prices. Today, the market is “drugged by AI,” but ultimately, QT should hurt stocks.
- Barry says we’re not going to get Core PCE to less than 2%. He maps out the math for us. It’s hard to imagine the Fed cutting interest rates because of inflation. The key will be unemployment rates. As Barry explains, the Fed would likely ease if the unemployment rate rose to 4.1%. It’s currently 3.7%.
- The estimated number of people leaving the workforce is keeping the unemployment rate low.
- We discussed recession vs. soft landing. Tax refunds are low, and buy-now-pay-later financing has increased. Debt-financing is fueling of the economy. History says this doesn’t usually work out well. And as Barry pointed out, the number of people using buy-now-pay-later debt for small ticket items like groceries has grown tremendously. It was designed for big-ticket items.
- Peter said, “This is the most confusing economic situation that I’ve ever seen.”
Click on the photo to watch on YouTube:
Click on the photo to listen on Spotify:
Understanding Long-short Investment Strategies
Our team is writing a series of papers with the goal of educating investors on various types of investments they can use to navigate the challenges we foresee ahead. If we’re correct in our outlook, we believe your wealth—depending on portfolio positioning—can get through the 2020s in fine shape. If we’re wrong, the types of asset classes that we’re focusing on have the potential to perform regardless. Why in the world would someone own a 4.30% 10-year U.S. Treasury note in a high-inflation, rising-interest-rate world when that someone could allocate to high single–digit to low double–digit yielding, short-term, floating-rate, senior-secured, asset-backed investments?
The first paper was titled, “Specialty Finance: Understanding Private Credit”. Our second paper, “Understanding Long-short Equity Investment Strategies,” is now available. Please click on the photo image below, provide some brief information and you will be taken both papers.
Future papers will explain the following asset classes that we believe are important exposures for the period ahead:
- Specialty Finance: Trade and Insurance (Income)
- Specialty Finance: Tax Liens (Income)
- Hedge Funds: Multi-Strategy (Absolute Return)
- Hedge Funds: Distressed Credit Long Short (Absolute Return)
- Real Estate: Multi-Family Housing (Income and Growth)
- Real Estate: Farmland – Agriculture (Income and Growth)
- Real Estate: Opportunity Zone (Income, Growth, Tax Advantage)
- Equities: High and Growing Dividend Stocks (Income and Growth)
- Equities: Active Investment Management
- Private Equity and Venture Capital
- Digital Currencies and Blockchain Technologies
- Hard Assets and Commodities: Gold, Uranium, Oil & Gas
- Energy Services and Infrastructure: Pipelines, Transportation
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
Here are several highlights:
Here is the full post along with link to Ray’s LinkedIn page.
What the latest readings from my bubble gauge say about the market.
As you know, I like to convert my intuitive thinking into indicators that I write down as decision rules (principles) that can be back tested and automated to put together with other principles and bets created the same way to make up a portfolio of alpha bets. I have one of these for bubbles. Having been through many bubbles over my 50+ years of investing, about 10 years ago I described what in my mind makes a bubble, and I use that to identify them in markets—all markets, not just stocks.
I define a bubble market as one that has a combination of the following in high degrees:
- High prices relative to traditional measures of value (e.g., by taking the present value of their cash flows for the duration of the asset and comparing it with their interest rates).
- Unsustainable conditions (e.g., extrapolating past revenue and earnings growth rates late in the cycle when capacity limits mean that that growth can’t be sustained).
- Many new and naïve buyers who were attracted in because the market has gone up a lot, so it’s perceived as a hot market.
- Broad bullish sentiment.
- A high percentage of purchases being financed by debt.
- A lot of forward and speculative purchases made to bet on price gains (e.g., inventories that are more than needed, contracted forward purchases, etc.).
I apply these criteria to all markets to see if they’re in bubbles. When I look at the US stock market using these criteria (see the chart below), it—and even some of the parts that have rallied the most and gotten media attention—doesn’t look very bubbly. The market as a whole is in mid-range (52nd percentile). As shown in the charts, these levels are not consistent with past bubbles.
The “Magnificent 7” has driven a meaningful share of the gains in US equities over the past year. The market cap of the basket has increased by over 80% since January 2023, and these companies now constitute over 25% of the S&P 500 market cap. The Mag-7 is measured to be a bit frothy but not in a full-on bubble. Valuations are slightly expensive given current and projected earnings, sentiment is bullish but doesn’t look excessively so, and we do not see excessive leverage or a flood of new and naïve buyers. That said, one could still imagine a significant correction in these names if generative AI does not live up to the priced-in impact.
In the remainder of this post, I’ll walk through each of the pieces of the bubble gauge for the US stock market as a whole and show you how recent conditions compare to historical bubbles. While I won’t show you exactly how this indicator is constructed, because that is proprietary, I will show you some of the sub-aggregate readings and some indicators.
Each of these six influences is measured using a number of stats that are combined into gauges. The table below shows the current readings of each of these gauges for the US equity market. It shows how the conditions stack up today for US equities in relation to past times. Our readings suggest that, while equities may have rallied meaningfully, we’re unlikely to be in a bubble.
For the Mag-7, some of our readings look frothy, but we do not see bubbly conditions in aggregate. We have somewhat lower confidence in this determination because we don’t have a high-confidence read on how impactful generative AI will turn out to be, and that is a significant influence on the expected cash flows of many of these companies.
You can go to Ray’s full post on LinkedIn by clicking here.
SB Here – An observation:
- I post short-term and intermediate-term Investor Sentiment readings each week in Trade Signals. Both are in the “Extreme Optimism” zone and are near the extreme high recorded in 2000 and 2007. Also, well worth the read.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
Note signals in the bottom section of the chart. Look at the vertical dotted red lines and note the recent spike above the 0.00 level in the bottom right-hand corner of the chart:
Source: @michaellebowitz
Longest weekly winning streak since 1989:
Concentration risk – the highest level since 1929.
Source: @DeutscheBank
“Buffett is whispering when he used a megaphone in the past. He’s whispering: Be very careful — problems do arise. He’s saying we’ll be ready, but that Berkshire will only be a buyer when no one else is a buyer.”
Source: Bloomberg, @jessefelder
It seems Buffett is not alone (put this in the positive column):
Source: Investment Company Institute, @charliebilello
Reverse Repo Program – this bears watching:
Source: Torsten Slok, @albertedwards99
You can follow me on X (formerly Twitter) @SBlumenthalCMG.
Not a recommendation to buy or sell any security. For discussion purposes only. Current viewpoints are subject to change.
Personal Note: Park City – WallachBeth 2024 Winter Symposium
Every year for the last ten years, I’ve attended the annual winter conference of my good friend Andy McOrmond and his team at WallachBeth Capital in beautiful Park City, Utah, with 160 investment professionals from around the country. The 2024 Winter Symposium is next week, and to say I’m excited is an understatement.
Meetings start early and end around 11 am, followed by skiing in the afternoon, après-ski, a well-earned cold IPA at 4 pm, and fun dinners at night. The younger folks hit the bars, and the older—and, may I say, wiser—folks quietly find their way back to the hotel. Andy has built an incredible culture at these conferences, and he invites clients who are open to learning with and from others. We all network, share investment ideas, and talk about the markets, the economy, and more. For one session, Gary Demoss from Investco will lead a talk on how to present better in a boardroom setting.
Leaders from all facets of the investment industry attend the weekend, and having that breadth at a conference like this is unique. I’m really looking forward to it.
Lake Tahoe is expecting seven feet of snow over the weekend, and the storm is heading toward Utah. My friend Thaxter, who’s a ski instructor at Park City, just told me to expect powder snow on Saturday and Sunday. I’ll be keeping my fingers crossed for a foot or more new snow.
My old man put me on skis at age three, and I did the same with my children. One of the best things Susan and I believe we did for our family. No matter what age or ability, at the end of the day you spent time with nature challenging yourself and enjoying the feeling. Do you remember when your children were young and you took them to a rock climbing gym. They were quick with a little fear on the drive in and were excited happy and alive on the ride home.
Two of our six children, Brianna and Matthew, just arrived home from four days skiing in Canada at a place called Chatter Creek. Following are a few photos to give you a sense of what skiing powder snow looks and feels like.
Brianna and Matthew, Chatter Creek, February 2024
Located about three and a half hours northwest of Calgary, the Chatter Creek ski terrain extends over 235 square kilometers. It consists of tree runs, old burns, wide-open alpine areas, and glacier skiing. The higher elevation ensures that the temperatures remain colder, the snow stays light and dry and is ideal for skiing or snowboarding.
You can find a cool video on Chatter Creek’s home page, which gives you a feel for what it is like. Happy on the drive home, indeed!
Wishing the very best to you and your family,
Trade Signals: Weekly Update – February 28, 2024
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Each week, we update our dashboard of indicators covering stock, bond, developed, and emerging markets, along with the dollar and gold charts. We monitor inflation and recession as well.
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