All posts tagged: interest rates

What is the U.S. Debt Ceiling?

Q4 2021 Market Commentary…

What is the U.S. debt ceiling? It’s simply a dollar cap limit that the US Government places on its own authority to raise money by issuing government bonds to continue to meet its obligations like social security payments, tax refunds, interest payments on existing debt, government employee salaries, military salaries, just to name a few. Since 1917, Congress has raised the debt limit 78 times (See Citation 1).

The U.S. government hit the debt limit of $28.4 Trillion (yes, with a T) in July 2 (See Citation 2). In fact, the debt load is a few billion over that as I write this newsletter, and the U.S. Treasury is pushing to get it raised by October 18. Since the U.S. Treasury debt is over the limit, something needs to get done, lest they are forced to default on the payments. Of course, members of congress rarely let that happen. They typical play hard ball with each other and then usually get it done in the 11th hour.

Raising the debt ceiling is not a healthy thing. It’s a necessary evil. With each dollar the government borrows, it steals purchasing power from future generations, and it makes all of us poorer for it. Unfortunately, the alternative is that the government defaults on their obligations. We each know hundreds of people who count on government payments, and no one wants those recipients to be adversely affected by a problem they didn’t create. Beyond the debt, we have other concerns…

• Will the $3.5 Trillion infrastructure bill get passed in Congress?
• Will higher inflation be transitory or here for a longer period?
• How much will the supply chain shock delay or reduce future earnings of companies?
• How will future employment numbers be affected by the corporate vaccine mandates?

As investment advisors, we grapple with questions like these constantly. Our only practicable response is to revert to economic data as it relates to outcomes of these uncertainties. As you know, we have adopted the silo method, by which we view the market through the lens of growth (GDP) and pricing (inflation). We spent most of Q3 in Silo 3 (decelerating GDP + accelerating inflation), and the stock market started to show signs of exhaustion in September as the S&P 500 Index 4.8% (See Citation 3) of its value.

If forthcoming GDP re-accelerates, it might indicate that the recent market swoon was episodic and not a reversal of bullish trend. The combination of accelerating GDP and accelerating inflation would put us back in a reflation condition (Silo 2), and that could be positive for stock prices. However, if GDP continues to decelerate, we could be in for a bumpy ride in Q4. When we get higher prices on goods and services amidst a period of lower economic output, future corporate earnings suffer. If economic recovery becomes less certain, investors get uneasy and market volatility appears. Let’s hope the post-COVID recovery data in October surprises us to the upside.

Citation 1 – https://en.wikipedia.org/wiki/History_of_United_States_debt_ceiling
Citation 2 – CBO.gov/publication/57371
Citation 3 – Yahoo Finance: S&P 500 Index Historical Return data

Future BrightWhat is the U.S. Debt Ceiling?
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What happens when interest rates rise?

2021 Q2 Commentary…
Can stocks and interest rates go up at the same time? Yes, they can, and they often do. Right now, we are in a period of recovery from economic shutdowns across the globe. As companies are forced to raise prices in 2021 and meet a return in consumer demand, we are watching inflation like a hawk. Specifically, we pay very close attention to the 10-year treasury note yield as our sentiment barometer.

First, a quick education on why the 10-year treasury yield matters…
▪ Treasury securities are loans to the federal government. Maturities range from weeks to as many as 30 years.
▪ Because they are backed by the U.S. government, Treasury securities are seen as a safer investment relative to stocks.
▪ Bond prices and yields move in opposite directions—falling prices boost yields, while rising prices lower yields.
▪ The 10-year yield is used as a proxy for mortgage rates. It’s also seen as a sign of investor sentiment about the economy.

How high can the 10-year treasury yield go before we do see it adversely affect the performance of the stock market? Some economists predict it’s 3%. Others say it’s 2.5%. The truth is that their predictions don’t really matter. What matters to us is the rate of change in inflation data that typically drives the change in interest rates. If the rate of change of inflation is increasing quarter over quarter, it signals a robust recovery is afoot, assuming job growth and GDP are accelerating, as well.

When inflation becomes too large of a problem to ignore, we typically see it unfold. Take the current housing market, for example. There are hot pockets in this country where new and existing home prices have been climbing double-digits for three years running. The FOMO on low interest rates coupled with tight supply and rapidly rising prices on homebuilding materials are creating a perfect storm for a severe housing price correction, or worse yet, a crash. Translate that to the rapid rise in prices of technology stocks or “Covid-Friendly” stocks, and there is similar risk. We don’t see it in the data right now, but the risk is always present because the data can change quickly.

All signs are pointing to a strong economy in Q2. As quarterly earnings start getting released in mid-April, we’ll likely see the companies negatively affected by COVID at this time last year crush their prior years’ results. Will that recovery strength be broad enough and strong enough to fight the inflationary price wave coming? Again, we don’t know until the data shows us. What we do have to go on is the data in hand (GDP accelerating, Inflation accelerating), and we’ll continue to maintain positions we deem as favorable to own under those conditions, knowing it could turn on a dime at any time.

Future BrightWhat happens when interest rates rise?
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