The word is growth!
“To understand modern economic history, you really need to understand just a single word. The word is growth. For better or worse, in sickness and in health, the modern economy has been growing like a hormone-soused teenager. It eats up everything it can find and puts on inches faster than you can count” – Yuval Noah Harari, Sapiens
The United States is considered the world’s number one economy with the largest consumer market, high standards of living, a haven currency that is envy of the world and an enormous GDP of US$21 trillion. This astronomical powerhouse of growth is powered by the fuel of US$25 trillion in national debt. By comparison, Australia has a GDP of $2 trillion with $740 billion in national debt.
Simply put, the US has more debt than the goods and services it produces. Sounds like a lot! In isolation, comparison of US debt with its GDP is terrifying. However, it adds context to know that the total net worth of United States is US$115 trillion and ultra-low interest rates assist the government in meeting their higher-than-ever debt obligations. As per the Data Lab, the net interest expense of the US government was lower in 2020 than it was in 2019. The reduction in interest expense has improved the affordability for home buyers as US home sales have surged to their highest level in 14 years fuelled by low interest rates and a pandemic that sent buyers scrambling for more spacious houses to accommodate working from home. Source: The Wall Street Journal
The idea of credit has been with us for centuries. In fact, without the invention of credit, the entire history of the economic world would have been impossible. Credit allows us to build the present at the expense of the future. Too much debt has become synonymous with burdening future generations. As Keynes said, "...printing notes is just as much taken from the public as an income-tax. What the Government spends, the public pays for".
Higher spending levels of today to absorb the pandemic shock requires more borrowing and the taxes needed to pay for those expenditures are pushed into the future. New US Treasury Secretary, Janet Yellen has indicated that while taxes should not rise right away, tax increases are part of the longer-term plan of the new administration. Yellen stated that the new administration is aware of the rising debt burden but still feels more must be done to combat the pandemic-recession.
Yellen believes the smartest thing to do now is to act big and take advantage of low interest rates. By acting big, she means Joe Biden is bringing an additional US$1.9 trillion pandemic relief package to support the US economy, subject to congress approval. This plan is addressed to individuals ($1tn), pandemic response ($400mn), and communities & small businesses ($440mn). The further support will absorb the shock of a resurgence in cases and address the part of the population that is vulnerable to the virus effects.
Japan and United States are prime examples that countries with strong institutions can get away with much higher debt than the rest. Specifically, United States enjoys the privilege of a world reserve currency which is hard to replace. During the COVID-19 crash, when investors all over the world realised the potential size of economic shock, they sold growth assets and took safety in cash. But not just any cash. They wanted US Dollars. Whenever the world economy seems uncertain, investors gravitate toward the greenbacks. Since the initial formation of the US government in 1776, the US Treasury has never failed to pay back its lenders and it is deemed as the safest of any major sovereign.
Credibility of its institutions and a credit history of around 250 years, enables the US to expand national debt freely. Perhaps, Janet Yellen is right, and it is the smartest thing to do, to defer the cost of a natural disaster to the future, the normal times. For now, the world seems comfortable with the high levels of debt backed by the assumption that the economy of the future will be more prosperous than the economy of today.
“In a healthy capitalist economy, wealth is always at risk” – Scott Galloway
The initial concerns of a democratic sweep for financial markets have been laid to rest by the 12% S&P500 gains from election day to the inauguration. Markets have now recovered not just what they lost in 2020 but they are at all-time highs despite the resurgence in cases and restrictions to contain the spread. A record number of investors made their first share purchase in 2020 to seize the greatest opportunity of wealth creation in decades; it is hard to argue with this success. It may give investors the illusion that exceptional profits from short-term trading is repeatable. There is no replacement for expertise, experience and professional advice while managing your life savings. We all have a friend who is flexing their 2020 gains or someone who is deemed a genius for investing in bitcoin. It helps to understand that these stories of exceptional performance are more frequent than what occurs in reality.
Stock movement is a function of the numbers and the narrative behind it. You do not have to look too hard to find investments where narrative has sidelined the numbers and the momentum has taken over the valuations. There’s great dispersion in performance across sectors and geographies. It is our long-term view, that active investing will outperform passive investing over the next decade, as many large companies held within the index will not survive and new small companies will become the part of index. Hence, it is essential to build a robust framework for choosing the next investment in your portfolio.
Saying that "markets are overvalued" is an oversimplification. There is a need to be specific as some valuations are hard to comprehend but others are elevated for good reasons: stellar earnings, low interest rates, healthy global financial sector and positive sentiment driven by vaccination and political certainty of the new administration. The corporate earnings season has started with positive surprises. So far, 15% of S&P500 companies have reported their earnings and 90% of these companies have beaten analyst expectations. These robust earnings are laying the concrete for positive growth in 2021.
Like most wounded things, the process of healing is fragile. As the world economy recovers from the pandemic, it is essential to cautiously embrace the optimism with all your defence mechanisms in place.
