In addition to the Nuveen Preferred & Income Opportunities Fund mentioned in the column, I am leery of AI hyperscalers with the exception of Google. At a 17 P/E, it actually trades below S&P average multiples and has consolidated in a relatively tight trading range for the past six months. For more conservative investors Verizon and AT&T have decent yields although threatened now by SPCX (SpaceX) in terms of mobile telephone markets. A flyer? Pimco PDI (Dynamic Income Fund), yielding 18% and managed by veteran managers Josh Anderson and Alfred Murata.
Neither a borrower nor a lender be,” wrote William Shakespeare, who was one of history’s greatest authors but obviously ill-versed in economics. Without lending or borrowing, our modern economic society wouldn’t grow very much, AI or not.
See more: US Debt Trap: A Crisis Without A Calendar
That is another way of saying that credit expansion is a fundamental and necessary condition to foster nominal GDP growth, here in the US and everywhere else in the world. Just doing the equivalent of trading seashells back and forth does not do much for that. Economic growth requires seashell/balance sheet expansion in order to promote long-term growth.
Milton Friedman’s work may have confirmed this with his “money matters” thesis, which argued that money supply is the primary driver of inflation. But his definition of “money” was always missing a link to my way of thinking. It is better to look at total credit in the US. This category includes government, mortgage and corporate credit and is now in the vicinity of $84tn, according to the US Federal Reserve. It has been expanding recently at an acceptable 5.9 per cent, just enough in a world of nominal US GDP growth of 8 per cent or so to stabilise asset prices or propel them higher given AI euphoria pricing GDP growth at higher-than-historic levels.
This is what is responsible for current equity levels. Should credit growth slow to 4 per cent or so, financial markets will probably feel the tightening.
But expanding balance sheets, whether they be personal, corporate or government, must in the medium/long term be balanced. Too much debt can lead to too much risk and too much equity can lead to less earnings per share growth under certain underperforming productivity cycles. Move them both at the same pace consistent with industry standards and economic growth more than likely expands as well.
Although hard to measure because of reporting lags, personal, corporate and government balance sheets have become unbalanced and growth in turn may suffer the consequences. Recent AI expansion financed in debt markets is anomalous by historical standards. Hundreds of billions of hyperscaler borrowings to finance data centre expansion are presumably a good bet on future growth promotion, but if not — “Houston, we’ve got a problem.”
The $1tn of AI-related investment that has been forecast for 2027 is likely to be funded by debt alone now that positive cash flow has disappeared.
It’s on the government balance sheet where risk is just as significant. Even the most optimistic economist must begin to recognise US debt levels are reaching “peacetime” peak levels with a net debt-to-GDP ratio of around 100 per cent. And boomer cohorts in populations will cause future social security, Medicare and Medicaid costs to swell. The transition to a future populated more by younger generations is years ahead.
What this implies for prospective financial markets is commonsensically apparent. Uneven balance sheet growth through taking on more debt has led to growth now, but likely lower later. Likewise, it has led to higher inflation now with little future respite absent global containment in fiscal/debt markets.
In such an environment, my view is: don’t own bonds, with the exception of one-year Treasury bills, which are now at 4.55 per cent. Be cautious with stocks at record levels as higher yields over time will contract profit margins. Be prepared for the end of “what you are used to” stock markets and higher volatility in prices for the benchmark 10-year Treasury bonds.
In terms of specific sectors, I am leery of hyperscalers unless they have price-earnings ratios of less than 20. And while I don’t own these stocks, the decent yields of Verizon and AT&T might be attractive for some conservative investors in the US market — though their businesses are threatened now by SpaceX’s Starlink Mobile in terms of mobile telephone markets.
There might also be opportunities in income funds trading at a discount to net asset values. Nuveen Preferred & Income Opportunities Fund, to cite an example where I don’t have a holding, is trading at about an 8 per cent discount to NAV and yields 11 per cent. However, like others in the sector, it would suffer if short rates move higher than expected.
Preserve and protect is my current investment motto.
Bill Gross
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