June 11, 2024 – As we approach the end of the quarter and I start to think about what we have seen in the markets, I continue to be stunned by the stock market action. Up, up, and up. Stock market valuations don’t seem to be coming in line anytime soon. Growth companies with profits are trading at levels several standard deviations away from the norm. Even profitable companies with little to no growth are trading at astronomical levels relative to their fundamental value.
I remember the debate in the 1980s on privatization in the U.K. (Thatcherism) and Reaganonics in the U.S., with the discussion focused on small versus large government. I was a politics student in the U.K. during Thatcherism, which was a fascinating time to be there. I found the hypocrisy of this movement in the U.S. so upsetting that I wrote my college thesis on it. It wasn’t about the merits of large or small government — that debate is well-grounded and thought out in the literature. It was the snake-oil salesmanship of tax cuts under the auspices of small government when it was the start of just the opposite. In 1981, when Reagan entered office the Federal debt was 30.6% of GDP. When Bush Sr. left office twelve years later, it was 64%. Today, it is 122% (Source: OMB, St. Louis Fed). And don’t go blaming just Democrats for today’s levels. The Republicans have been the largest abusers. The only exception to this cycle was the Clinton Administration when debt levels came to 54% by the time he left office.
I bring up these facts as a prelude to this link to the Arendt Center’s blog from this past Sunday, “Socialized Risk.” The article is a very good one and suggests a rather interesting answer to my question above. Crudely summarized, the socialization of risk, starting with the response to the Great Financial Crisis, has led to investor risk-taking that is decoupled from the realities of finance. Because of Fed/Treasury/Congressional action over the past twenty years, there is no situation in which you will lose. The nosebleed valuations on assets are no longer a relevant factor. Investing now is just a function of what will happen to the asset next week.
The dangers here are obvious, and not. Federal debt at these levels can continue to climb and will. But at some point, gravity will take over again and something will break. The least of which is a default on the U.S. debt because of astronomical interest expense (which is now 11% of the annual budget). The risk is to the U.S. Dollar, the easiest tool to inflate your way out of debt and the fastest way to kill future growth. Treated as the base currency for the bulk of international trade, it is a global situation that is too important to fail. Of course, until someone finds an alternative for the dollar. Then it is lights out for the markets and our foreign policy.
The elephant in the room is the upcoming election. For reasons that have to do with company policy, I am not allowed to discuss this in a meaningful way. But for those of you who know me, you probably know what I want to say. One cannot understate the importance of the outcome in the context of the U.S. and the global order.
More will follow in the next Market Update in early July.
Regards,
– DBM
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