Debt hawks see doomsday at every new milestone in America’s steady ascent up the debt ladder. Yet, in the eyes of many sophisticated stock market participants, the debt warnings are a distraction, keeping these uncouth worrywarts from making money. (Though the two groups do not line up perfectly, it would seem that debt hawks are disproportionately represented among those who have been uneager to invest in the stock market since the last big crisis.)
Enter Charlie Bilello, who asks on today’s Seeking Alpha how the national debt figures as a risk for stocks. If you’re a debt hawk, most of Bilello’s article will provide cold comfort. He systematically goes through various markets during which the debt has risen and finds the market climbing at an even higher rate. He doesn’t argue that debt and stock market gains are inversely related, i.e., he’s not saying debt is a good thing; to the contrary, he warns against confusing correlation with causality.
In the end, he offers the warm comfort of a conclusion with which everyone should agree:
The stock market is not the economy and it certainly isn’t the national debt. Your best protection against the risk of a debt crisis in the future? Diversification, diversification, diversification.”
I admit to being allergic to high debt. I don’t advise people to avoid investing – as regular readers of my article know. Rather, my usual message is pretty much the same as Bilello’s: diversification, diversification, diversification.
And yet, I do see America’s $20 trillion debt, now equal to 104% of nominal GDP, as reason for profound concern. (To be clear, Bilello does not say that is he is unconcerned, only that mounting debt has not been a barrier to stock market outperformance.) Indulge me please, as I step out of the realm of quantitative economics to put this in perspective. I once read a book by the historian Paul Johnson in which he offered the novel argument that the great inflation that kicked off in 1964 led directly to the 1960s-era counterculture. Essentially, he argued that just as inflation led people to question the currency, so too did it lead people to question authority. (Note: I write from memory of a book I read maybe three decades ago.)
This argument resonated with me. Cultural change doesn’t occur in a vacuum. Economics and society are part of a whole. And so, if inflation is corrosive of authority, I think that a system of credit that enables people to consume beyond what they have earned is corrosive of responsibility. As it becomes ingrained in our national economic behavior, it will be (has been) mirrored in our cultural behavior.
Bilello includes a chart showing how much “fiscal space” a country has before the debt truly becomes a problem. The U.S. remains in the safe zone, according to this analysis (from Moody’s). At the danger zone end of the chart, one sees Japan, Italy, Greece, and Cyprus with no room for maneuver at all. My gut tells me that the Moody’s analysis is flawed, i.e., that the U.S. is not as safe as presented. Looking at this chart, I viewed it not as an aggregation of discrete national economies but as an organic international economic system. The bars were not an index of national economic virtue but, to me, appeared as a table of dominoes. Japan may fall first, but any nation that doesn’t maintain responsible fiscal policies is likely to be adversely impacted once the cascade begins.
The economist Hyman Minsky is famous for his theory that stability leads to instability, that “each state nurtures forces that lead to its own destruction.” That is why the sort of economic leadership we need today is to step back from the debt abyss to which we are lemming-like knowingly advancing.
Your thoughts, as always, are welcome in our comments section. And, here are additional financial advisor-related links:
- Douglas Tengdin, CFA: The pursuit of safety can make you more vulnerable.
- David Merkel, CFA: Perceived vs. real risk tolerance.
- Investment Cycle Engine, Inc.: Risk is endogenous to the financial system.
- Charles Hugh Smith: Our financial buffers are thinning.
- Russ Thornton: Your financial plan is probably wrong – and that’s okay.
- Institute for Innovation Development: Advisors are ceding FinTech to banks.
For more content geared to FAs, visit the Financial Advisor Center.