Why You Shouldn't Panic About Government Debt

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Includes: AGG, BOND, DIA, IWM, QQQ, SPY
by: StreetAuthority

Summary

Many investors are concerned about the nearly $19 trillion in public U.S. debt, but this number is not as bad as it seems.

Nearly one third of the outstanding debt is held by federal government agencies such as the Social Security Administration, FDIC, the Postal Service Retirees Fund, or the Department of Labor's.

The government will be able to continue to refinance the rest at decent rates as it gets its fiscal house in order.

Large cap, dividend paying blue chip stocks should be a cornerstone of a moderate investment portfolio.

By Adam Fischbaum

I have a long time client who is always convinced that the financial sky is falling. Recently he called me, worried that the nation is $19 trillion in debt. He's not alone in this worry -- $19 trillion sounds like a lot. But is that a real number? And how fast is the debt train hurtling towards us?

So I decided to do some research.

In the most recent audit of the Bureau of Fiscal Services for fiscal years 2014 and 2015 by the Government Accountability Office, the total gross federal debt outstanding is $18.138 trillion. That's 4.5% less than $19 trillion. Don't you feel better?

Here's one of the most interesting facts I uncovered. Nearly one third of the outstanding debt, 27.6% to be exact, is held by federal government agencies such as the Social Security Administration, FDIC, the Postal Service Retirees Fund, or the Department of Labor's unemployment trust fund.

If we subtract federally held debt then that means that $13.12 trillion of what the report refers to as marketable securities (they can be resold at any time) are held by the public.

But all this debt is going to mature one day? Yes it is. In fact, some of it comes due very soon.

58% of all marketable federal securities held by the public, worth $7.4 trillion, mature within the next four years. The remaining 42% stretches all the way out to 2045.

Will the government retire over $7 trillion in debt by 2020? My guess would be no. Will the wheels fall off of our society and spiral into a "Mad Max" style existence? Probably not. What will happen? Have you ever refinanced a 30-year mortgage?

I don't know this for sure, but it seems likely that the government will end up kicking the $7 trillion can down the road. Way down the road, meaning 20+ years. Can they really pull that off? With interest rates low and likely to remain low in the near term, I'd bet the farm on it.

Here's a survey of some of the most credit worthy 10-year government bonds out there:

10-Year Government Bond Yields
US 1.58%
Canada 1.21%
France 0.20%
Japan -0.29%
UK 0.82%
Germany -0.03%
Click to enlarge
Click to enlarge

When it comes to government bond yields, the United States is the best of a bad situation. Investors are currently paying Japan and Germany to keep their money. In the current environment 1.57% is practically high yield.

But before you start chewing your fingernails down to the cuticles over the burden of interest expense; let's look at the trend over the last 25 years.

Click to enlarge

The average interest rate on outstanding federal debt has decreased 80% over the last two and a half decades. That's a 3.3% average annual rate. In short, our borrowing costs are low and should remain low as we figure out the $7 trillion problem. At the same time, it seems as if our debt will remain attractive to investors seeking high quality debt with some kind of yield.

Oh, and in terms of debt ownership, China doesn't "own" the United States, unless you consider 6.6% a controlling stake.

The short version: more than likely, the government will be able to refinance $7 trillion at decent rates as it gets its fiscal house in order. And rates, no surprise, will remain stubbornly low. But what would you rather have, low interest rates or fiscal Armageddon?

So what do investors do? Large cap, dividend paying blue chip stocks should be a cornerstone of a moderate investment portfolio. Investors should pay careful attention to valuation metrics such as forward P/E ratios and stock price relative to 52-week highs. Companies should have strong franchises, deep moat businesses with solid balance sheets and operating histories. Winners would include names such as Cisco Systems (NASDAQ:CSCO), Apple (NASDAQ:AAPL), Wal-Mart (NYSE:WMT) and pharma giant AbbVie (NYSE:ABBV).

The federal debt numbers are so big that they seem insurmountable. But they're not. It's a serious challenge facing the nation, but the problem looks very workable in the current rate environment, and whether we want to admit it or not, there are some smart cookies in the Department of Treasury and at the Federal Reserve.

Again, these numbers are big, but solving the problem practically is hardly impossible. The trade off, though, will be persistent low interest rates. The stocks I mentioned have an average annual dividend yield of 2.9%; nearly twice that of a 10-year U.S. treasury. They will better serve investors going forward.

This article was originally published on StreetAuthority.com.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Adam Fischbaum owns these CSCO, AAPL, and WMT in client and family accounts.