“The US is driving a car blindfolded against a wall when it comes to its economy”, according to Edmund Harriss, chief investment officer (CIO) at Guinness Global Investors.
US public debt is aggravating to a point where “something needs to happen”, or the repercussions will be felt across the world, potentially jeopardising growth both domestically and internationally.
Investors should therefore consider long-term US stock market returns against a backdrop of “a toughening domestic environment, whether they like it or not”, Harris warned.
US debt-to-GDP ratio is at historic highs. After averaging 65.7% from 1940 until 2023, it reached an all-time high of 126.3% in 2020, when the government provided unprecedented financial stimulus packages during the pandemic, and has remained elevated since.
While the country is accumulating debt and higher rates of interest over time, financially its economy is becoming more vulnerable to shocks, Harriss explained, and “somewhere along the line, you hit the wall”.
Hitting the wall is the point when the market says ‘we are no longer prepared to fund this’ and it won’t accept borrowing 2% of GDP to fund spending, and borrowing three times as much again to pay the interest on the debt that is accumulating.
In the UK, we hit our wall in September 2022 with Liz Truss’s disastrous mini-Budget.
“Truss had decided, probably rightly, that the economy needed to be stimulated to grow, but the manner that she chose spooked a section of the market and it snowballed,” he said.
The special privileges afforded the US still mean the country is regarded as a safe place to be and suggests the instruments themselves are liquid, and this can go “quite a lot further”.
But if nothing changes, the US too will reach a Truss-like point, with a set of circumstances that are either wildly expansionary or where there is some doubt as to the willingness or ability of the government to pay. For Harriss, it is not going to be the stock of debt that bothers people, but the servicing ability.
The topic becomes of international concern when we look at how much US debt is financed domestically (60%) and how much is held by foreigners (40%).
“How willing will foreign players be to continue to hold unsustainable levels of US debt, considering that the large funders are those that are building up foreign exchange reserves and not all are friendly to the United States?,” he asked.
The issue becomes even more pressing as there is no sign that the practice is slowing down.
The Congressional Budgetary Office expects $22trn will be added to the national debt over the next decade
“From what we can see today, there is no pathway for a gentle reduction. Both presidential candidates offer expansionary policies, both of which will cause an increased deterioration in the deficit over and above the long-term forecast,” Harriss said.
“The electorate is so used to a continual injection of sugar, in the form of tax cuts and consumer benefits, that it is utterly unprepared for what’s coming. The question is when and how will this blow out, will it happen by force and how is policy going to be shaped bring this under control? Because it must be.”
The only area spending may be cut under a potential Trump presidency is defence, with the president candidate hoping that European NATO countries pick up the bill. But in thinking that, he “is underestimating the repercussions on global balance sheets”, according to Harriss.
Should Trump cut US defence spending from 3% to 2% of GDP, the primary deficit would drop to 1% from 1.5%, which “would help quite a lot”. But it would also tighten up European budgets “quite considerably”, with repercussions on other areas as well, including the green economy.
“If governments don't have that much to spend, money has got to be taken up from other areas, and that will feed into a to a changing backdrop.”
The long-term implications of this are expected to play out over the next 10 years, but the problem is “critical”. Despite this, he warned there is an “absence of an obvious plan to slow things down”.
As for what investors can do to protect themselves, Harriss said it is not the time yet to run for cover. However, they must be aware that domestic-driven growth in the US has “a bit of a shelf life”.
“Structural themes are working against US growth, as opposed to other areas of the world where structural themes, such as wealth accumulation and rising household incomes, are actually supportive,” he said.
From a stock picking point of view, the best companies to focus on are those that are exposed to the markets where the growth is going to come from and that are cash-generative enough to be largely self-funding, while also favouring companies that can deliver performance independently of the economic cycle.