An Unnerving Feeling – June 21, 2024

Wealth Management • Jun 22 2024
An Unnerving Feeling – June 21, 2024
Morgan Lewis Posted on June 22, 2024

An Unnerving Feeling

On Friday, Goldman Sachs’ head of execution services, Bobby Molavi, summed up the current market zeitgeist nicely. As Molavi put it, “For a year where the biggest market in the world [S&P 500] has hit its +30th all-time high…and 6 of the 10 biggest stocks in the US hit individual all-time highs…there is an elevated amount of anxiety…there is an unnerving feeling of something not being entirely healthy beneath the surface.”

This week, that unnerving feeling primarily emanated from the rapidly deteriorating US fiscal position. The US Treasury reported that in May, the US fiscal situation boldly charted new territory with the widest monthly “True Interest Expense” deficit of our modern era. True Interest Expense is entitlement spending plus interest paid on outstanding debt. In May, that total came to $467 billion, or fully 144% of total tax receipts. That’s 144% of tax receipts before we even get to all other spending on Defense, Agriculture, Education, Office of Personnel Management, Transportation, Homeland Security, and the Labor Department. Not at all inspiring.

Under the circumstances, it was no surprise that, according to a Financial Times article titled “IMF warns US on ballooning fiscal burden,” the International Monetary Fund delivered US policymakers their latest slap on the wrist. 

According to the FT, “Gita Gopinath, the fund’s first deputy managing director, said it was time for advanced economies to ‘invest in fiscal consolidation’ and address how they plan to bring debt burdens back down to pre-pandemic levels.”

“The temptation to finance all spending through borrowing really is something that countries should avoid,” Gopinath said. 

The IMF said that it expected the US to record a fiscal deficit of 7.1 percent of GDP next year—more than three times the two percent average of other advanced economies—and warned that fiscal deficits in both the US and China specifically posed “significant risks” for the world economy.

Just as soon as the sting from the IMF wrist-slap faded, the US Congressional Budget Office released an update to the budget and economic outlook for the period of 2024 to 2034. In the report, the CBO raised their 2024 fiscal deficit estimate by $408 billion, or 27% over their February estimate. Since February, the CBO has increased its projection of outlays in 2024 by $363 billion and decreased its estimate of revenues by $45 billion.

The US deficit is now forecast to never fall below 6% of GDP between now and 2034, but in reality, the problem is much worse. The CBO assumes a deficit, at minimum, of -6% for the entire 10-year forecast window despite the fact that it assumes 175-200 basis points of Fed rate cuts, no recessions for the next 10 years (recall that in the last three recessions, deficit/GDP jumped 600, 800, and 1200 bps respectively), and that the unemployment rate never moves above 4.5%.

The US fiscal deficit of 7.1% of GDP is totally unprecedented outside of a major war, a serious recession, or some other enormous crisis. It projects a nearly $2 trillion deficit. To put that in perspective and underscore the problem, using the World Bank’s estimate for global GDP and global GDP growth (a rosy estimate of 3.2% real), that means almost 30% of total global GDP growth will be needed just to finance U.S. deficits. How is that in any way, shape, or form sustainable? 

Alarmingly, if you just cut that optimistic growth estimate in half, financing US deficits requires a whopping 57% of global GDP growth. Again, shockingly, this fiscal negligence is, for the first time ever, now taking place at a time of near-peak full-employment and with capital gains tax receipts booming courtesy of an S&P 500 at all-time highs. 

This sovereign debt bubble is a bone-fide powder keg, and our policymakers look like children playing with matches. The debt spiral is already beginning to spin out of control, and that’s with global growth assumptions that leave no room for error.

This week, economist David Rosenberg presented the possibility of considerable error in those global growth assumptions. Rosenberg said, “I actually think that, right now, we’re setting the table for the recession that got delayed, but did not get derailed. And I think that a lot of those folks that threw in the towel last year on the recession call will be spending the summer picking up those towels.” 

If Rosenberg is right, then the Federal Reserve has two massive incentives to start cutting interest rates sooner and more sharply than the market currently expects. First, to keep economic growth and thus tax receipts as robust as possible, and second, materially reducing the government interest expense on the $35 trillion and growing US debt pile. After all, the eye-popping $7.6 trillion in interest-bearing U.S. public debt maturing by November offers 7.6 trillion reasons for rate cuts. 

Rosenberg continued by translating the implications of the writing on the wall; “I think that once the Fed starts to catch up to other central banks in terms of their rate cutting, the bull market in the US dollar will come to an end. And that will be very good news for gold, silver, and commodities in general.”

As Jay Powell himself said in a 60 minutes interview last December, “the U.S. is on an unsustainable fiscal path. The U.S. federal government is on an unsustainable fiscal path. And that just means the debt is growing faster than the economy.” Sometimes simple is best, but if you want to relieve that unnerving feeling, it certainly seems to be a good time to own gold, silver, and commodities in general.

Weekly performance: The S&P 500 was up 0.61%. Gold was off 0.76%, silver was up 0.48%. Platinum rebounded, up 3.94%, and palladium was up 2.90%. The HUI gold miners index was up 1.97%. The IFRA iShares US Infrastructure ETF was nearly flat, up 0.14%. Energy commodities were volatile and mixed on the week. WTI crude oil was up 3.43%, while natural gas was off 1.56%. The CRB Commodity Index was off 1.32%. Copper was off 1.18%. The Dow Jones US Specialty Real Estate Investment Trust Index was off 0.22%. The Vanguard Utilities ETF was down 0.65%. The dollar index was up 0.26% to close the week at 105.44. The yield on the 10-yr U.S. Treasury was up 3 bps to close at 4.26%.

Have a wonderful weekend!

Best Regards,

Morgan Lewis
Investment Strategist & Co-Portfolio Manager

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