It was said
“(Geopolitical events as well as US political polarization) may very well be creating risks that could eclipse anything since World War II.”
– Jamie Dimon, Chairman of the Board and Chief Executive Officer, JPMorgan Chase
I worry that these types of comments will spook investors to break from their investment plans. Geopolitical conflict has been a poor predictor of stock prices. Even during the world wars, the Dow Jones Industrial Average posted positive returns.2 More recently, the MSCI Poland Index (US dollars) climbed 39.2% from the day Russia invaded Ukraine (Feb. 24, 2022) through the end of March, outpacing the S&P 500 Index over that period.3 While I’ve never felt comfortable quoting Nathan Rothschild’s “Buy when there is blood in the streets” because it sounds harsh, but it has often been good advice.
Learn more in Military conflicts haven’t derailed the long-term growth of stocks.
Since you asked
Q: Should we be concerned that the US federal government’s interest burden as a percent of the nation’s gross domestic product is rising drastically?
A: The annual deficits will rise, but it may not have as big of an impact on the debt-to-GDP ratio as suspected. Let me explain.
- Yes, long-term interest rates have risen sharply,4 and deficits have widened.5 Compounding the problem, the disharmony in Congress doesn’t inspire confidence that the policymakers do anything to address it.
- The Congressional Budget Office (CBO) expects the US government to run fiscal deficits ranging from a low of $1.5 trillion in 2024 to a high of $2.6 trillion in 2034. It also expects US government borrowing costs to be around 4%, nearly double the interest rate in the 2010s.5
- As a result, the federal interest payment is expected to climb from $659 billion in 2023 to $1.6 trillion in 2034, or from 2.4% of GDP to 3.9% of GDP.5
- If the estimates are correct, there’ll be $13.3 trillion in interest payments made over the next decade.5
- The CBO, however, also expects the US GDP to increase at an annualized rate of 3.9% over the same period, in line with the average interest rate on debt. That would mean $14.3 trillion in additional output.5
- If US nominal growth is in line with or above the government’s average borrowing cost G≥R (growth≥interest rates), then the debt-to-GDP ratio is likely to remain in a tight range. Fortunately, US long rates historically have traded based on the growth potential of the country — not on its perceived creditworthiness.6
Read more about US debt in What is the US national debt’s risk to investments?
Automate my job?
Each month, I pose a question to ChatGPT — the artificial intelligence-driven chatbot — and assess the response.
Q: Which parts of the stock market have tended to perform poorly as interest rates rise?
A: Sectors that typically perform poorly as interest rates rise include interest rate sensitive sectors such as utilities and real estate investment trusts (REITs). Additionally, sectors with high valuations or those with long-duration assets, such as some technology and growth stocks, can also face headwinds as interest rates rise. Overall, investors have tended to favor sectors with lower sensitivity to interest rate changes, such as consumer staples, health care, and certain areas of the financial sector.
Good answer ChatGPT. I’d also add that shorter-term cyclical assets and smaller-capitalization stocks are likely at risk in the very near term when rates drift higher.
I cannot imagine it will be too long until I ask ChatGPT about the asset classes that perform well when rates fall. I don’t believe that we’re too far from the point when rates moderate. It’ll entail investor conviction that the economy and inflation are becoming more subdued, however. At that point, a risk-on trade, such as that experienced in Q4 2023, when cyclical sectors outperformed and small- and mid-cap stocks rallied, could reemerge.7
On the road again
My travels took me to Las Vegas for the Investment Wealth Institute summit. Do I gamble? “Every time I order out,” to quote Lieutenant Frank Drebin of Police Squad. The meeting location gave me the opportunity to open my session by debunking the view held by select investors that the stock market is like a casino. The odds of any casino game are less than 50%, and the longer you play, the more likely you are to lose money. On the other hand, the S&P 500 Index, since 1957, has posted positive returns in 75% of the years and 100% over any 15-year period.8 The longer you stay invested, the more likely you get positive returns. That sounds like the exact opposite of a casino.
See you in May, the gateway to summer!