#76 S2N: Is the Debt Too Big? (Part 2)

S2N Spotlight

I ended yesterday’s “Spotlight” with this sentence: “This is not the final picture; as we know, the US runs a major fiscal deficit, so we need to address this before giving the US economy the all-clear.”

Yesterday, I made the case that, despite the fact that the total debt burden has grown dramatically over the last decade, its serviceability when looking at the interest cost relative to tax revenue is not as bad as it has been in the past. However, that is the poor man’s version of analysing the affordability of the debt burden. One should not only look at the interest component of the expenditure relative to income. You need to look at the interest relative to total expenses and debt.

I am pretty sure most of you reading this note have heard of the US fiscal deficit. This is the gap between income and expenses. In business terms, the countries losses on its P&L statement. What you can see over the last decade is that the deficit has been around $1 trillion a year, with the COVID fiscal stimulus being the major spike in the chart.

So how does Uncle Sam fund the deficit? He does what most people do these days: he borrows money, and that is why the federal debt continues to grow to $35 trillion with no end in sight with all the profligate spending by the government. In the chart below, it turns out that interest as a percentage of income and expenses is very similar and has been worse before.

The black line above shows the $ interest expense divided by the $ debt translating to the effective interest rate the government is paying on the debt currently sitting under 5%. It has been a clear beneficiary of the secular drop in interest rates from the 1980’s.

The bottom line is that any increase in interest rates will simply add to the deficit, all other things being equal. The US dollar in theory should be under pressure because of it but for now it remains the worlds reserve currency and enjoys a special privilege, so despite all that I have shared above and concurring with what I said yesterday, the US can continue to kick the can further down the track.

The safest place with all of this is probably gold. However, despite gold making new all-time highs it is still well below its 2010 highs relative to inflation.

S2N Observations

Canada cut rates yesterday by 0.25% with more cuts anticipated.

Australia reported poor GDP numbers 0.1% for Q1.

Nvidia becomes the 3rd company to join the $3 trillion club (it just feels too easy).

I found an interesting relationship with the VIX and the US High Yield Index. If this relationship holds the only place for high yields to move is, excuse the pun, higher.

The next chart further echoes how complacent this market is. It has been 324 days since the SP500 has had a 2% down day.

I thought I would leave you with some bad breadth .

The Nasdaq Composite Index made another all-time high yesterday in line with the S&P 500. What is interesting is the cumulative number of Nasdaq Composite companies making 52 week lows continues to out number those making 52 week highs on a cumulative basis. Its the first time I ever created this chart, it has been a pretty good market timer in the past. It just isn’t loving this rally. Dr Bearman is in the house.

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