It's on again. After a quiet winter and early spring, the financial media is focused on the debt problems. While the focus is mostly on Europe, many countries outside of Europe are just in as much trouble as European nations. For example, the U.S. and Japan have mountains of debt which are not likely to be repaid anytime soon.
When the debt problem surfaced for the first time, world stock markets responded badly, but everyone was hoping that the problem would be solved soon. Many investors thought that all it would take would be a few meetings among the world leaders to solve the debt problems big nations are facing today. After many meetings that spanned many months, there is no solution on the table yet. Europeans are cutting costs as fast as they can, Japanese and Americans are not motivated enough as their bond yields are really low right now.
Imagine a country that has debt at 80% of its GDP. This country would have to have a budget surplus of 4% for 20 years in a row just to pay off the principle of that debt, without even touching the interest. Obviously, it is incredibly difficult for a country to have a budget surplus for 20 years in a row and chances of any big country such as England, Japan, U.S., France, Spain or Italy paying off its debt within the next 20 years is highly unrealistic. Another option would be to decrease the debt to more "manageable" levels. This comes with two problems, 1) how do you set the level where debt is manageable, 2) if a country's debt is simply moved to "manageable" level, wouldn't it motivate the country to take on more debt?
As investors are anxiously waiting for the debt issues to be resolved soon, it seems more obvious each day that headlines will be busy with debt problems for years to come. The debt levels in the developed nations will continue to disturb the stock market for at least another decade. Unfortunately, no meeting of any kind can solve this problem.
No one really knows how to solve the debt problem without hurting their population significantly to the point of causing riots. If a government cuts spending too much without investing into growth measures, this will cause many problems. However, there is a problem with government's investing into growth measures as well. Is it really a government's job to stimulate growth in a country? Shouldn't government just create an environment where businesses can prosper and leave the rest of the growing to businesses? This is very difficult to achieve in today's overly regulated economies.
If things aren't reversed, in about 15-20 years, almost every developed country will either default on its debt or see very high rates of inflation due to increased money creation/printing. Debts can't just get canceled either. In most countries, the country's debt is mainly owned by retirement funds, investment banks and insurance firms located in the same country. Defaulting on this debt would create havoc similar to the one that followed bankruptcy of Lehman Brothers. Who knows, maybe World War III will be a consequence of this debt problem.
The biggest challenge in front of developed nations today is lack of growth. If an economy can't grow, the country's tax revenues can't grow. If a country's revenues can't grow, it will have to cut spending deeper and deeper in order to balance its budget. These days, most of the growth happens in Asia and Latin America. Developed nations are too costly for manufacturing jobs, leaving them with mostly service jobs. Cost of living and cost of labor would have to come down significantly in the developed nations before any kind of rapid growth is seen in these countries.
What does this all mean for investors? If an investor is staying on the sideline until European debt issues clear, he or she may have to wait on the sideline for a decade or two. I wouldn't stay away from investing altogether though. After all, many of us are saving money for retirement and the money has to grow somehow. Because the market is likely to trade back and forth within a range in the following years, I would focus my investments in dividends and option writing. This way, even if the stock market stays flat, one could still see his or her money grow.
Some of my favorite dividend payers are Annaly Capital Management (NLY), SeaDrill (SDRL), Chevron (CVX) and AT&T (T). Those that still want plenty of growth can focus on successful growth stories of this decade that consistently beat the market such as Apple (AAPL), McDonald's (MCD) and Qualcomm (QCOM).