Will we ever learn? I know, I know…. it seems a bit extreme to go back to school forty years later. Then again, we haven’t experienced this kind of thing since the early 1980s. I’m specifically thinking about the current financial environment where interest rates have dramatically spiked in a little more than one calendar year and perennial deflation fears(Europe, Japan etc) have been replaced by a genuine global inflation challenge. For illustration, this week the ECB raised its key deposit interest rate to 4%. Think back to summer of last year and European interest rates were actually negative. Frankly, the cost of money(rates) affects everything and when one considers the sheer pace of change we need to go back to the books or, at least, re-visit a number of emerging risks not seen for decades. Even hidden ones.
Equity is not debt but…. the relationship is typically very tight. The text books say higher rates hurt business and equity valuations but not this year. Global equities are up 15% year to date and the tech-heavy Nasdaq index is up a whopping 33%. Of course, you will have read about AI excitement and the fact that the giant technology names are doing most of the stock market heavy-lifting this year. That makes sense when you compare previous debt/inflation shift periods. The fortunate truth for big tech is that they have absolutely no debt! Back in the 1980s the biggest companies in the world were the likes of GE, Exxon and General Motors; classic old economy industrial names with traditional balance sheets and plenty of debt. In contrast, some of big tech’s customers are not so fortunate and a few things have caught my eye….
- US corporate bankruptcy rates (via Chapter 11 filings) are at a 12 year high. Chapter 11 filings surged by 68% in the first half of 2023 versus the year earlier period (Source: Epiq).
- Retail bankruptcies can also reveal consumers tightening spend so the demise of the iconic Bed Bath & Beyond in April was a big deal in the US. However, it’s not just the US experiencing retail stress. The collapse of 400 Wilko stores and its 12,000 employees in the UK shows that not every self-imposed economic challenge can be solved by filling the English Channel with sh*t, slashing school safety budgets or machine-gunning dinghies.
On a more global(and serious) basis, there are two key personal assets which are impacted by higher interest rates and debt dynamics. One well-flagged, one not so much. Mortgages as debts attached to properties are attracting the headlines but this could be a slow burner in many countries where markets use fixed rate mortgage products rather than variable rate products which are already causing stress in the UK and Ireland. Thankfully, that cohort of variable borrowers is a much smaller one than in previous rate spike cycles. One cannot forecast the future but it is quite likely that the re-financing, or re-set, of fixed rate products over the coming years will be in a significantly higher rate environment than previous negotiations. Now, for some good news….
Pensions might bore people but something’s up. Income. Yep, a senior stockbroker was telling me last week that the hottest product for him this year was boring old government bonds, but with a relatively new twist. These debt instruments are actually generating decent income for people’s pensions for the first time in ages. It might not sound very exciting but the possibility of earning 4-5% per annum from almost risk-free assets is a huge bonus for pension funds which have been starved of income for years. That’s a great result for individuals but for governments with stretched debt profiles it’s going to hurt.
We are approaching another US government debt ceiling deadline at the end of the month. Sadly, it’s not just women’s bodies being held hostage by the lunatic wing of the Orange Toddler cult on Capitol Hill. House Speaker, Kevin McCarthy, and the GOP have reneged on the original debt deal struck with the Biden administration so there are an anxious few weeks ahead. However, the longer term debt scenario for the US and other countries is beginning to have real budgetary consequences. The US is hurtling towards a $33 trillion government debt total and the servicing of that debt is meeting the recent reality of higher interest rates. Debt costs for the US government have increased by 25% this year and will be approaching an annual cost of $1 trillion soon. That’s more than the US spends on its defence budget.
In the UK another form of government debt is in the headlines – the state pension. Currently, this commitment is costing the government over £100 billion per annum. The problem is that the Tory government have bribed their last remaining voters, retirees, with a “triple-lock” promise. In effect, pensions must increase every April by the highest of the following three cost of living rates: inflation rates, wage growth rates or 2.5%. Well, it’s not going to be 2.5% next April. Try 8.5%, on top of the 10% increase last year. Given the UK already has other, ahem, economic challenges it is no huge surprise that RishiGPT Sunak (or more recently nicknamed “Inaction Man”) is beginning to wobble on that commitment. At least the Tories have 13 years practice of false promises but other governments will have awkward budgetary choices in the coming years. And yet, I have become more hopeful in recent times….
The fiscal support of governments in transforming industrial policy and moving away from fossil fuels can be viewed as a must-do climate emergency response. However, there are two key policy consequences which could be of longer term benefit. First, as seen in the US, Bidenomics is not just capital spend. It is creating jobs, new industries and growth. Europe and Asian economies are following suit and, in a world facing the increased threat of populism and false promises, we might actually be witnessing a second key policy consequence – the death of one of the great canards of modern politics. Trickle-down economics. The decades-long conservative/GOP orthodoxy of believing tax cuts for the asset-rich would ‘trickle down’ into main street growth never ever materialised. Bidenomics is proving that governments can use a far more effective policy lever to spread and grow the wealth. However, that lesson must be balanced with old-school debt discipline as I fear the headlines will keep coming on that front. Always learning, eh.