No matter what you celebrate this time of year, we have reason to believe there might be a little ‘holiday magic’ in the air in December. The economy continues to surprise the naysayers and is still chugging along. It’s merry and bright indeed!
The Bull is looking strong for now and is likely to have one last stand that carries us into 2024. In October’s blog, we accurately predicted the November rally. Our team anticipates that December will be equally sparkly and spectacular for the following reasons:
1. Hedge funds that were shorting the market in October lost $43B. These and most other funds that are behind on their benchmarks will chase equities even higher through the end of the year to make up for their poor performance. And they will chase equities with leverage.
2. The November rally was led by big tech and small caps. We also saw the cryptocurrency space surge once again. The multi-sector participation in the rally suggests it may have more legs to the upside.
3. Historically, the month of December in a pre-election year is bullish for the market.
4. A weakening dollar combined with 10-year rates cooling off adds a tailwind to the mix.
While the stock market is forward-looking, we are watching it closely. When the stock market gets dislocated from reality, we’ll be ready to position investors accordingly. But there’s another threat looming that requires our constant attention: high levels of debt in the system. With a lot of factors at play, which we’ll review below, we’re attempting to forecast the future impact and how best to position our portfolio when the inevitable collapse begins.
Our national debt has been increasing steadily every year to the point where we are not able to meet our budget deficits with tax revenues alone. In September 2023, it surpassed $33T. The Federal Reserve has to continue to increase its balance sheet to meet its debt obligations, and the creation of new money will lead to long-term devaluation of the dollar.
Low-interest rates stimulate the economy, generate tax revenue, and, ultimately, reduce the national debt. They make it easier for individuals and businesses to borrow money for goods and services, creating jobs and eventually increasing tax revenues. In contrast, rising debt reduces business investment, slows economic growth, and erodes confidence in the U.S. dollar.
A recent Penn Wharton Budget Model suggests that, under current policy, the U.S. has about 20 years to take corrective action, after which no amount of future tax increases or spending cuts could avoid the government defaulting on its debt, either explicitly or implicitly.
This time frame is the best-case scenario for the country, under market conditions where participants believe that corrective fiscal actions will happen in time to avert a crisis. If, instead, the market starts to believe otherwise, debt dynamics would make the window for corrective action even shorter. The implication here is that the U.S. may have more time for corrective action provided it takes some steps in that direction. Otherwise, this debt game could be over a lot sooner.
Here’s where debt stands on both the corporate and consumer sides:
In the first half of 2023, corporate debt issuance increased sharply as U.S. companies returned to the bond market. Nonfinancial corporations issued more than $397B in debt, which was a 36% increase from Q1 and Q2 in 2022. This money was borrowed in a high-interest rate environment. When the business cycle turns, which we anticipate shortly, highly leveraged companies will struggle to service their debt, further stressing balance sheets at the banks.
It’s not much rosier for consumers. According to consumer debt data from the Federal Reserve Bank of New York, Americans’ total credit card balance in Q3 of 2023 is $1.079 trillion. That’s up from the previous record set in Q2. According to data from the American Bankers Association, Americans carried a balance on 56% of all active credit card accounts with an interest rate averaging 22.77% in September.
Amazingly enough, just 2.77% of Americans’ total outstanding credit card balances are currently delinquent by 30 days or more. Unfortunately, though, the unemployment rate is expected to accelerate when the business cycle turns, leaving people with no option but to default on their debt. This will be additional stress for banks.
Our analysis indicates that the market is pricing in a soft landing where the Fed is able to tame inflation with its restrictive monetary policy while avoiding damage to the economy (and thereby the employment rate.) For now, that certainly seems to be the case: the economy is chugging along and employment is holding steady at historically high levels.
If the market continues to price in this Cinderella ending, then asset prices should inflate further in the coming months. But rest assured, while you’re decorating the Christmas tree or lighting the menorah, we will be watching out for early signs of dislocation in asset prices before we head for the exits.
In the meantime, enjoy the Santa Clause rally and the spirit of the holidays!
