US debt mountain presents biggest threat to equities
With a stalemate meaning politicians cannot raise taxes or cut spending, Rathbones’ Carl Stick is worried about how the world’s largest economy will get its ever-increasing deficit under control.
By Carl Stick, Rathbones
Thursday September 27, 2012
Eighteen months ago, we highlighted a few storm clouds on the horizon: the eurozone, a slowdown in China, and US leverage. Those clouds remain above us even now.
The situation in Europe is remarkably fluid, making it difficult to price assets. We worry about the German economy, because expectations are high that it will continue to function as the engine of Europe, even though its trading partners remain predominantly European.
China will be the engine of global growth over the next 10 to 20 years, but the economy must transition from relying on infrastructure spend to boost GDP, to becoming an economy driven by domestic consumption – that will not be easy to achieve.
However, it is the US that really worries us, or should we say the complacency around the US and its problems.
We are all viewing the US as a place that is going to generate earnings growth. Data has not been too bad, but the fiscal cliff looks like the tip of a much bigger problem.
Our basic premise is that ultra-easy monetary policy is all well and good, but without a fiscal solution, it is redundant.
The reality in the US is this: it has major long-term debt issues and in the short-term it is not generating enough tax revenue. Without the political will to raise taxes or cut welfare, how does it finance expenditure?
No-one is going to make any decisions between now and the end of the year – it presents a political minefield.
Post-election, it is going to be very difficult for the president to make any clear decisions during the first six months of the year.
The sclerosis in the political process is extraordinary. The biggest anxiety is that creditors to the US will take fright; borrowing costs will increase and the debt spiral will resume.
Looking at it in isolation, is more quantitative easing (QE) really going to work? The policy of sustaining low mortgage rates is providing a powerful stimulus that should, theoretically, support consumer spending.
However, the inflationary consequences, indeed the consequences for inflationary expectations, are anyone’s guess.
Also, what of the labour market, which remains a huge structural deficiency? We are sceptical of the benefits of QE on employment levels. Some estimate that a further $500bn of QE will only reduce unemployment by a nominal amount.
Combined with the debt problems, it is clear that the US Federal Reserve alone cannot fix the economy, and government policy-makers must act as well.
When no-one really knows why the economy remains at stall speed, and the fiscal authorities refuse to play ball, investors should be wary, particularly as these fears may not have been priced into equities this summer.
Performance of fund vs sector over 5-yrs
Source: FE Analytics
Carl Stick is the manager of the Rathbone Income fund, which has returned 4.71 per cent over five years, compared with 7.10 per cent from the IMA UK Equity Income sector. The views expressed here are his own.