Patrick Iturra, Asset/Investment Manager & Consulting.
Opinion: The Brewing Storm: How Soaring Global Debt Could Rattle Markets September 19, 2023
Domestic and International Concerns: A Glimpse Back
Investors grapple with an increasingly unpredictable landscape in the face of soaring global debt. Domestically, challenges such as prolonged inflation, impending interest rate hikes, potential banking issues, and overpriced housing compared to incomes echo past financial crises. Abroad, the unresolved Russia-Ukraine conflict adds to the mounting pressures.
Bonds and Equities: A Tumultuous Dance
Looking back to February 2022, I vividly recall foreseeing a protracted bear market just as Russia advanced and the Federal Reserve began tightening. Consequently, the S&P 500 took a 25% hit, and bonds experienced double-digit losses. However, on the bright side, equities have demonstrated a commendable rally this year, but the bond market has lagged, with rates soaring to unprecedented heights.
The Real Cost for Investors
Given this backdrop, the scenario remains bleak for investors. Actual losses, adjusted for inflation, are steadily eroding their purchasing power. Moreover, the duration of these downturns often glossed over, could spell increased trouble for those drawing from their portfolios.
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The Silent Threat: Global Debt
Indeed, a lurking menace threatens a steeper market plunge—a staggering and swelling global debt. To put it into perspective, this debt surpasses 270% of global GDP when considering governmental, private, and non-financial corporate obligations.
Debt’s Double-Edged Sword
From a historical viewpoint, debt surges have often bolstered GDP. By leveraging more, entities can outspend their revenue and income. Conversely, curbing this debt can constrict consumption, presenting structural economic and market hazards.
Balancing Act: Pathways to Equilibrium
While finding direct historical parallels is challenging due to today’s unprecedented debt levels, Michael Pettis provides a noteworthy framework. Specifically, he suggests excessive debt creates a disparity between GDP (supply) and wealth and unemployment (demand). Thus, achieving a balance could involve:
- Financial Repression: This involves a combination of suppressed rates, elevated taxes, and inflation.
- Financial Crisis: Think of the rapid adjustments witnessed during 2008-09.
- Prolonged Financial Stagnation: A drawn-out scenario, much like Japan’s economic journey.
The Perils of Perpetual Debt
Interestingly, some economists propose that governments can perpetually amplify debt without facing repercussions. However, such a perspective, in my opinion, is logic-defying. As a result, as government debt mounts, more tax revenue gets funneled into servicing it, severely restricting fiscal agility during economic downturns.
U.S. Treasury’s Warning Signals
As we delve deeper into this debt maze, the looming uncertainty around its ramifications on U.S. wealth and incomes becomes more pronounced. For instance, the evident trepidation in recent Treasury auctions, pushing yields to new annual peaks, is a cause for concern.
Conclusion: The Shadow of the Bear
Ultimately, any significant shift in economic indicators or investor sentiment could halt the equity market’s positive trajectory this year. If bearish sentiments take root, we might very well witness a resurgence of the previous year’s losses, possibly signaling a return of the bear market.
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