Debt doesn’t worry me…yet

Founder and Publisher of the Switzer Report
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I received a great question from a subscriber, Bill, who, as an old Chartered Accountant, can’t ignore the indebtedness of the US government. And while he did not question my optimism on stocks for 2013, he basically put it this way: “As a former CA and insolvency practitioner, that looks like a financial basket case to me”.

Bill pointed out that the numbers looked shocking and the Yanks are going to need to slash untouchables, such as military spending, and “tell the Chinese their Treasury bills are not worth anything”.

No quick fix

He also pondered whether economic growth of 6-7% could be the solution and while this is hoping for too much, I believe this will be how the problem becomes less problematic.

Now some of my subscribers might not care about these higher order issues, while others could be comatosed about it and have remained too defensive since 2008 and have missed good years on the market in 2009, 2010 and 2012.

Now be clear on this: there are no quick fixes for a country where the debt to GDP ratio is approaching 100% but we need to keep a few things in perspective.

After the Great Depression and World War II, the debt-to-GDP ratio held an all-time record of 113%. Debt was at $241.86 billion in 1946, about $2.87 trillion in current dollars.

This eventually shrank, thanks to economic growth, to around 30% under Reagan but even grew under his stewardship and was up to 50% under Bill Clinton but did fall into the 30-40% band.

The good news

Bill points out that there are some positives out there, such as the USA possibly being self-sufficient in energy supplies within a decade, thanks to new gas supplies, the drag of a war in the Middle East delivering a budget benefit, and of course the China, as well as the Association of South East Asian Nations (ASEAN) growth stories, will help US companies.

In fact, the latter part — China, along with the ASEAN group of countries and the likes of Brazil, Russia and India — all provide hope that global demand will ride to the rescue of a pivotal economy for our investments, the USA.

Debt issue will return

Bill, I have to confess that your question is beyond me but if I were doing a doctoral thesis, I’d steal your question as the basis of a great paper!

I suspect the debt issue for the USA will come back to haunt the stock market and be at the heart of the next crash, if economic growth — worldwide — doesn’t ride to the rescue of the US economy and Wall Street.

However, in the short- to medium-term, I think the improvement in US company balance sheets since 2007, along with better personal balance sheets of American households, with interest rates so low and a Fed, as well as the Obama Administration, both stoking the fires for economic growth, there’s probably two years of good share price growth ahead.

Remember, the debt growth was to avoid a Great Depression and that was a worthwhile reason to be so irresponsible, but over the next three to four years we need to see good growth, with contained inflation, prevail. We need US politicians to lift their game to embrace sensible attacks on the budget deficit and debt reduction.

Waiting for March

In March this year, there are planned automatic sequestration cuts to spending that could hurt US growth and there has to be an agreement to allow the debt limit to go above the $16.394 trillion. All this could spook the market and stocks could lose out, despite the fact that I think the current earnings season will help stocks.

If we see a quick solution to the debt and spending cuts, the indexes would spike higher but we could see another pre-fiscal cliff situation, where everyone was so sure that a solution was coming they bought stocks without much fear.

March could be different and could trigger that historical expectation of “sell in May and go away.” It happened in April last year and so there could be a rerun this year.

However, if a good solution to debt and spending challenges turn up, then it could be a case of buy in May and stay!

I’d love to be certain and so all I can suggest you do is “watch this space!”

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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