Off To The Races?

TLDR:

1. Debt Ceiling Lifted
2. Budget Deficit for May Surges To $240B
3. Inflation Softens, The Fed Pauses

If there were any better indication of an all-clear in the market, the last couple of weeks were it. The giant debt ceiling gorilla in the room has left to eat bananas elsewhere. New issuances have resumed, and the markets are off to the races.

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Some might be scared to invest now, given the continuous straight line up the markets have experienced post SVB. But that would be a mistake. If you don't think markets can be up yet another 15%, the only thing worse than missing 15% returns is missing 30%.

Yes, we are in full-on greed mode. But the danger is that this could last a long time. While buying all-time highs might not feel comfortable, the implication that "you can somehow sit in cash while timing the market" is even more preposterous.

However, this time, we have an ally on our side. And it’s the following chart:

Yes, this is an impartial projection from the government itself about the state of its debt. Notice how it's denominated in GDP units. Which means that if we are growing GDP by 4% a year nominally, and government debt grows by 4% a year, this chart would be a flat horizontal line.

Yet it's growing. And accelerating. Not 10 years later, not 5 years later. Every year going forward.

How does this relate to stocks, you may ask? Well, every liability (in this case, the government's) is someone else's asset. And with more assets, people feel richer and are more inclined to spend it or buy more financial assets on credit. Thereby fueling either asset bubbles or sustained inflation.

For the purpose of deciding to be invested in stocks or not, however, it's a moot point. The money supply is going up at an alarming rate. It's not for us to decide what the government should do to manage this, but at the very least, we should position ourselves to defend against this scenario.

And if that wasn't enough of an impetus...

Debt Ceiling Lifted

The deal reached at the end of May lifts the cap entirely until Jan 2025. This essentially means carte blanche to spend until the end of Biden's presidency. I'm not saying Biden will spend recklessly. It's actually a quite bipartisan affair:

Pretty much every 10 years or so, we have a once-in-a-century event that causes the US to go into deficit by more than 10% of GDP. If all things go well, the deficit will still be around 5% of GDP.

Notice how given the current level of rates, the light pink interest expense has nearly doubled and is only set to increase regardless of how much the US tightens the belt. Yes, there are other provisions in the deal that will cut spending… But it's pretty much like arranging the deck chairs on the Titanic at this point.

And what more to affirm our beliefs than...

Budget Deficit for May Surges To $240B

Yes. In May, the month where the government was essentially running out of cash and needed to conserve every last penny. In that month, the deficit was $240B dollars.

I'm really not trying to be an alarmist, but for anyone who thinks this is normal, have a look at the Turkish Lira:

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And for those that couldn’t see the dollar index in the top chart, here it is zoomed in:

The dollar dropped over 2% since the debt ceiling has been reached. The USD is definitely not the Lira, but for those who are mildly concerned about this development, it's important to note that a lower US dollar is a natural stabilizing force, making imports more expensive and exports more competitive.

So why not add fuel to the fire by pausing rates?

Inflation Softens, The Fed Pauses

Inflation softened to 4% last month, and the Fed paused as expected. Regardless of how hawkish Chairman Powell tried to be, the markets were not having any of it. The S&P bounced back strongly following the initial knee-jerk reaction that we'd have 2 more hikes down the pipe.

If the dollar weakens another 5-10% against the other majors, their governments will begin feeling the competitive pressures to ease their own monetary policies. To be clear, the fiscal situation doesn't look much better in the developed world.

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So yes, maybe 1 or 2 more hikes. But the pause is a discrete event that signifies the beginning of the end for the tightening cycle. How do you position yourself in the next few months?

Ivan’s Take

This will be controversial, or perhaps not for those who have been following our articles. But close your eyes and buy. Even if something sideswipes the economy (I'm looking at you, commercial real estate!), there's really no meaningful catalyst otherwise on the downside.

Sentiment on AI has been nothing short of euphoric, with firms big and small dropping everything they are doing to get on the bandwagon. The monetary tailwinds are upon us with the most recent pause, and inflation has been consistently dropping without surprises.

And with the lifting of the debt ceiling, government spending will add a further few trillion dollars to the economy by the end of the year.

For the even more discerning investor, it is important to note that not all sectors will benefit from the monetary tailwinds. We are now in a standard textbook situation where cash-flowing businesses will significantly outperform their debt-laden/money-losing counterparts. Place your bets!