November 17, 2023
By Steve Blumenthal
“U.S. reaching a point where our debt problem gets even worse.”
– Ray Dalio, Source CNBC
Kick the can was a fun game to play when we were kids. A Coke can was placed in an open space and was guarded. This person would cover their eyes and count to twenty. Then yell, “Ready or not, here I come.” The rest had scattered around the neighborhood. The objective was to be the first person to run back and kick the can before getting tagged.
This week, our friends in D.C. slowly walked up to the can, pulled their legs back ever so slightly, and dinked the can a few more turns down the sidewalk. Averting a partial government shutdown, House lawmakers approved a plan this week that would fund the government until early next year. The measure now moves to the Senate, where the leaders of both parties have signaled support.
Last week’s OMR was about the coming “Second Stage of Tightening.” If it wasn’t on your radar, I shared it to put a light on the issue.
What I believe is happening is that people are starting to wake up to the size of the fiscal problem. To put some perspective on this, the U.S. is currently spending ~ $2 trillion more than it is taking in (the U.S. fiscal deficit). If you keep kicking the can down the road, you reach the end of that road at some point. And that end is in sight.
Wrap your head around this:
- Approximately 50% of outstanding Treasury debt matures in the next three years. If the debt rolls over at the current level of interest rates, the interest cost alone will jump from ~ $680 trillion to $2 trillion.
- That is equal to the total fiscal deficit today.
- A $2 trillion annual deficit may jump to $3.3 trillion due to the interest cost increases alone.
- The latest US GDP was ~ $27 trillion. $2 trillion means the fiscal deficit is 7.4% of GDP. $3.3 trillion is 12% of GDP.
- The interest expense will be 50% of tax receipts in five years.
This is not sustainable. Fundamentally, the Fed can control short-term rates, but repricing that much debt puts pressure on the longer-term rates—one of the problems of accumulating too much debt. Sadly, the U.S. is not alone.
“We are at the point of that acceleration, which creates the supply-demand problem,” said Ray Dalio. It’s made worse by the other issues he’s written about – internal political issues, internal social conflict, and external geopolitical challenges with China. He added, “Financially strong means: do you earn more than you spend? Do you have a good income statement as a country? And do we have a good balance sheet?”
Either interest rates must come down, government spending must come down, or taxes must go up. Or some combination of all three.
U.S. Balance Sheet – Total Assets vs Liabilities
In your investment account, if you have $1 million in stocks and borrowed $500,000 on margin, your net value is $500,000. If your stocks drop, you start to get margin calls. If your stocks fall 50%, you are wiped out. $500,000 in stocks and $500,000 in margin debt means your account is worth $0.
The U.S. has $220.5 trillion in total assets and $211 trillion in total liabilities. In some sense, the U.S. balance sheet is similar. Source
Except the government owns a money-printing machine, and you and I do not. Inflation wave number one is subsiding. Inflation wave number two will come on the heels of the next round of QE.
Will U.S. voters vote for the person telling us our taxes are increasing, social security benefits are decreasing, and medicare benefits are decreasing? Or will they vote for the person selling us more sugar? We are going to get the sugar. More sugar feels good in the short term, but it is poison to the body. Free money creates more debt, which, given our current situation, is poison to the system.
Tuesday’s Stock and Bond Market Rallies
Tuesday was the culmination of the turn in the market narrative, from the belief that the Fed will keep interest rates higher for longer to a belief that the economy is heading for a soft landing and Fed interest rate cuts will follow. A one-tenth of a drop in CPI, and it was risk-on. The 10-year Treasury rate, which hovered near 5% a few weeks ago, dropped below 4.5%. Bonds and stocks rallied. Short-covering accentuated the move. Investors are reacting to any sign of a slowing economy that may lead to a Fed pivot. The S&P has had its best two-week stretch since October last year.
This type of overreaction keeps on happening. And likely will continue to occur on both the upside and the downside. Deutsche Bank strategist Henry Allen counts six other times since 2021 that investors have anticipated a “dovish pivot” by the Fed, all of which were eventually reversed.
It’s hard to see how this time will be different. As detailed above, the structural funding and cost issues must be resolved.
Dust off those old market timing tools. Interest rates will fall with a weakening economy. Then, more QE sugar. Then they’ll rise again. Expect volatility to continue, both up and down.
Grab that coffee and find your favorite chair. Below is a link to an excellent Howard Marks – David Rubenstein discussion. Same sage advice on investing and positioning for the period ahead. Not a recommendation to buy or sell any security.
Here are the sections in this week’s On My Radar:
- Howard Marks and David Rubenstein
- The Uninverting Yield Curve
- Random Tweets
- Personal Note: Happy Thanksgiving
- Trade Signals: Weekly Update, November 15, 2023
(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.)
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Howard Marks and David Rubenstein
(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.)
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The Uninverting Yield Curve
Following is a shortened summary of what I shared with you in last week’s OMR. This can be a confusing topic, so I thought I’d try to simplify it.
The important idea is to avoid recessions. In recessions, economies slow, earnings slow, liquidity in the banking system dries up, and equity markets tend to dislocate. Envision the stock market down aggressively in the -30% to -50% range. It could be more, could be less.
For a number of months, I’ve been posting a chart from NDR showing the inverted yield curve. Specifically, it looks at the difference between the yield on the 10-year Treasury note and the 6-month Treasury bill. It is rare that short-term interest rates are higher than long-term interest rates. The longer you agree to tie your money up, the higher the yield you should earn. But when the economy overheats, the Fed raises the Fed Funds rate (short-term interest rates), and like now, you can reach a point where short-term rates are higher than long-term rates. It doesn’t happen often. You can think of it as a sign that the economy has a bad fever.
In the NDR chart, the average lead time from the date the yield curve first inverted was 11 months before the recession started. Here is the link to last week’s OMR post, where you can find the chart. At the of October, we have gone 16 months since inversion, and we’ll tick 17 months in a few weeks.
Think of the first inversion date 16 months ago as the warning shot across the bow. Basically, don’t worry too much, and start to narrow your focus.
William Hester, CFA, ups the game, saying a better signal is when the yield curve normalizes by one percent (100 bps) or more.
The following chart (data from the US Treasury) shows the yield data sorted by maturity from 1-month T-Bills to 30-year Treasury Bonds. The majority of the time, the 3-month rate is lower than the 10-year rate, but that hasn’t been the case for the last 16 months. I’ve highlighted in gray the 3-month and 10-year rates. In red, I highlight the yield curve moving from Most inverted to Uninverted by more than 100 bps—a little eerie that October 19 date. I was in Hawaii on that day in 1987 when my phone rang at 2 am Hawaii. It was my Merrill Lynch manager demanding I immediately return home. The market crashed, and people were losing their money and their minds.
What Hester is identifying is highlighted above in yellow. He is saying that his study shows this is a more precise indicator.
Next, skip down and look at the orange arrows in the next chart. The arrows point to the periods when the yield curve was uninverted by 100 bps. Note how close they are to the vertical gray bars.
Could it be different this time? Sure, but probabilities say otherwise. Soft landing? Hard landing? No landing? There will, without question, be another recession. They are a normal and healthy part of the business cycle. The next recession will likely be more challenging due to the debt burden.
From William Hester, CFA, Senior Research Analyst, Hussman Strategic Advisors
Not a recommendation to buy or sell any securities. Opinions expressed may change at any time.
Random Tweets
Inflow to US Large Cap Funds – Largest since Feb 2022
Soft Landing?
Druckenmiller Recession Indicator in Recession Territory
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.
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Personal Note: Happy Thanksgiving
The kids are coming home for Thanksgiving. Grandma Pat is flying up from Florida, and nephews Mike, Dan, and niece Ashley are driving in from Penn State. I love when we are all together and can’t wait. We’ll be one short this year. Brianna is in Australia with a friend. She is taking a month off before moving to New York to start a new job in January. It will be nice to have her back on the East Coast.
I flew to San Diego on Wednesday for meetings on Thursday. I’m writing you today from a downtown hotel room overlooking Petco Park. It is really quite a view. It’s sunny with temperatures in the low 70s.
Stephen, Steve, Syd, Kevin and Howard
A red-eye home departs at 10 pm PT tonight. I hate redeyes! Tomorrow morning will look something like this: favorite chair with favorite cat. And coffee!
Best friend – Miles the cat
There will not be an On My Radar next Friday. I’m taking the day off and golfing with sons Matt and Kyle, and good friend Steve in the annual Stonewall Black Friday golf scramble.
Thanks so much for spending time with me each week. I appreciate it more than you may know.
Wishing you and your family a warm and wonderful Thanksgiving holiday!
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Trade Signals: Weekly Update, November 15, 2023
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Notable this week:
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