The Debt Ceiling and Market Issues, and Bloomberg Interview
Markets have begun to come to grips with the idea that the US may face the following:
1) Credit rating downgrade
and
2) A need to prioritize who gets paid from the US Treasury.
Both issues have been the on the horizon for some time. In fact two of the major agencies, Moody’s and S&P, have already issued warnings. Previously, markets basically ignored these warnings assuming that Washington would get its act together cut spending raise revenue and lift the debt ceiling to accommodate Treasury’s obligations.
First a quick lesson in Economics.
US Debt to GDP ratio is near 60% this is the lowest debt to GDP ratio of the developed economies. We are on the backside of a massive recession, triggered by the previous administrations housing, spending, fiscal, monetary and tax policies.
That said, we are nowhere near a debt to GDP level that would seriously impair growth going forward. In fact, one might argue that given where yields are we should have seen Treasury issue a lot more debt because the payback levels are so low.
At any rate there is not an issue – at the moment- with this chart.
While many wealthy American’s will readily tell you that they would happily surrender a touch more of their income to solve both the budget crisis and put the US on a more firm footing going forward, they won’t do it if there are not significant spending cuts. While austerity may hurt growth and crimp the nascent jobs recovery it more than likely will not push the US into recession.
The point here is to notice that we have more than enough revenue at the IRS to fund the existing obligations and will regardless of the debt ceiling being raised.
Issues of importance and concern
1) Equity market values
As we have long held, equities represent fair vlaue to us in the 1200-1250 range. Although dividend sicosunt models suggest much higher valuations we are skeptical. That said, we are looking at adding to our equity positions below 1275. Volumes have remained light on both up and down days. This suggests to us that many investors remain in cash, bonds, precious metals and diversified currency baskets.
2) US Government Securities
Our analysis suggests that there are only the Aug 5 and 11 tranches of paper that are at risk. This assumes two things:
a) that the politicians will rethink things within the 2 weeks that a downgrade and ensuing chaos would occur
and
b) that the White House would instruct Treasury to prioritize US Debt payments ahead of many other Govement obligations. In fact the latter could be the case for an indefinite period of time. Our further analysis suggest that for every $ Treasury takes in only be btween .35 and .45 cents is used for debt service and retirment of principal.
Here is my Bloomberg interview from yesterday: “Ellis Likes Utilities, Industrials Amid Debt Debate”.
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