There are pockets of hope in 2016 for a more sustainable economy. The jobs picture, at least portrayed by the government, has improved based on their measures. Inflation is low. Corporate profits are high. Under the light of the media the economy is improving. However, as I have been sifting through the data, there are two areas of concern I think we need to discuss. First is Government Debt. We owe as a nation, $18 Trillion in total debt, and we are borrowing $500 billion a year. We are borrowing three times what we were borrowing in 2007. In 2006 U.S. total debt was around $8 trillion. Today our tax base in this country is $3 trillion in a good year and $2 trillion in bad year.
Graph Provided by FRED
It will be extremely difficult to pay this back. As far as I can tell we have never attempted to pay down the U.S. Government debt. Our country can be viewed as a person with Credit Card Mania. Our Government is a “pay the minimum payment” type government. They continue to borrow money, but only make the interest payment. Just look at the chart above. I have been preaching to my clients for the last couple of years that the world is at the end of a long-term credit cycle and that at some point our country and the rest of the world for that matter will be forced to deleverage. Think of it like this, if you make $100,000 per year and spend $110,000, you will be able to continue in this lifestyle for many years, until one day the interest payments that you must pay monthly on your loans exceed your monthly income. At that point you will be forced to stop spending and to start deleveraging. When I speak of deleveraging all I mean is beginning to pay back what is owed. I believe we are witnessing a global debt bubble, and someday will be forced to “pay the piper.” The economy began deleveraging in 2008, however, the massive levels of printed money helped fuel our government debt bubble. You see, when the Fed prints money, they buy Government bonds in the open market. When they buy unheard of amounts of Government bonds they force interest rates lower. By forcing interest rates lower, they allow the Government to borrow more money. This has gone on for seven years and total government debt has exploded, more than doubling. This is unsustainable. The Fed raised rates last month in an attempt to prove the economy is on solid footing. I believe this was a mistake and we will see the Fed print money again in the future. Our economy has not stabilized to that of a normal economy. The key drivers behind the growth of our economy are, population growth, and productivity growth. Both are lacking. This brings us to our other concern: Corporate Profits. Our economy has been artificially propped up by Fed money printing. We look at the stock market and think the economy must be doing well, after all the stock market has been going up. However, looking at the fundamentals of the market, we see that corporate profits are at all-time highs, not because sales are booming, but because they have been caught up in borrowing “Cheap Money.” What have they done with this money? Have they used it to increase productivity, (a key driver of our economy)? The majority has been used to buy-back their own stock. This gives the illusion of increasing profits. If they buy back stock, their earnings per share increases, not because of better business, but solely because there are less shares in the market. This too, is unsustainable.
This is not meant to sound like a doom and gloom report. It is just fact finding analysis. Deleveraging doesn’t necessary mean market meltdown, or capitulation. It just means, at some point we will have to get back to good old fundamental growth, not Fed induced asset bubble growth. For there to be a major debt debacle, interest rates would need to rise to levels not seen since the 1980s. I don’t see this happening in the near term, but knowing it is possible is key to protecting portfolios if it becomes a reality.
Capital Preservation is Key
Markets Cannot Go Up Forever
The markets can and likely will continue to move higher in the short-term. However, just like all market cycles, we will eventually see a recession or economic slowdown. If we can manage to deleverage without causing major panic as interest rates rise over time, we should see “normal recessions.” However, if market psychology shifts and interest rates begin to move too high, too fast. The Government debt bubble could cause major sell offs across the globe. This is why it is key to not only understand the fundamentals that drive an economy and market, but to also be prepared to take action. Most of you know our firm believes in capital preservation for portfolio success over long periods of time. Our unique approach using both fundamental analysis as well as our proprietary algorithm helps to preserve capital.
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