Weekly eLetter 5/19/2023 – Rocket Surgery

Every now and then we like to drag out an illustration that we think is useful to help people comprehend the magnitude of large numbers. In the past, we have focused on the question of “Just how big IS a billion?” Today, in the light of inflation, expanding debt and the impending potential doom of a default by the U.S. Government, we will look at another large number: a trillion. That’s pertinent because the trillion is apparently the new billion — the United States Public Debt now sits at about 31 trillion dollars. Got it? OK, here’s the exercise:

Using the familiar units of seconds on your stopwatch you might be interested to know that for one million seconds to pass takes about twelve days. So, how much bigger is a billion? Well, for one billion seconds to tick by on that trusty stopwatch it will take about 32 years. And, what about one trillion seconds? That’s easy to figure out; just add a set of zeroes. So, the answer is 32,000 years.

Now you can understand what former Senate Majority Leader Everett Dirksen was thinking when he famously cautioned that federal spending had a way of getting out of control. Word has it that Dirksen said, “A billion here, a billion there, and pretty soon you’re talking real money.” Sadly, I’m here to tell you that, as a country, we are way deep into ‘real money’.

And the issue now on the table is do we once again raise the ‘Debt ceiling’? For a bit of quality discussion on that subject, we shall turn to Brian Wesbury and Robert Stein, Chief Economist and Deputy Chief Economist respectively at First Trust Advisors. With their kind permission, we reproduce here their article of earlier this week. I think you will find it interesting and informative.

Battle of the Budget
Brian S. Wesbury, Chief Economist
Robert Stein, Deputy Chief Economist
Date: 5/15/2023

It’s hard to open up a newspaper these days and not see a scary story about the debt ceiling debate. The Biden Administration is saying that a “default” is approaching if an agreement isn’t reached soon.

The US has enough revenue to pay all bondholders, but a roughly $1.5 trillion deficit this year means that if the debt ceiling isn’t lifted, it won’t be able to pay all its obligations, maybe even entitlement payments under Medicare, Medicaid, or Social Security.

We’ve been here before, and as we have seen in the past, we think an agreement will be reached and that all bond payments will be made on time. We also think it’s very unlikely that any payments on entitlements will get delayed. Much more likely is that the Congress and White House will agree on some sort of framework to hold the line on increases in discretionary (non-entitlement) spending. Maybe they’ll also agree to form some sort of bipartisan commission to review proposals to reform entitlements.

In other words, lots of smoke and very little fire. If an agreement is reached to limit discretionary spending, those limits are not likely to last. History is clear. In the past 90 years, non-defense government spending has grown ten times faster than GDP, and that trend is unlikely to change anytime soon. We’re also guessing that if an entitlement commission is formed, that the recommendations would not come up for a vote until after the next presidential election and would likely fall short of the necessary votes.

All of this is important because the path of federal spending, largely dominated by entitlements, is unsustainable. According to the Congressional Budget Office, this year Social Security, Medicare, Medicaid, and other health-related entitlement programs will cost the federal government 10.8% of GDP. Thirty years from now these same programs will cost 14.9% of GDP.

Tax revenue is scheduled to be higher, too, due to the expiration of some of the tax cuts enacted in 2017 as well as “bracket creep” (incomes tend to rise faster than inflation, resulting in a larger share of income getting taxed at higher marginal tax rates). But the gain in revenue relative to GDP is less than one percentage point, which is well below the expected increase in spending.

You don’t have to be a rocket scientist to figure out where this is heading. Simple budget accounting trends forecast a huge increase in federal debt, which means a huge increase in net interest payments by the government. In other words, the real problem isn’t whether the US raises the debt ceiling right now, it is how the US will pay for all this spending over time.

At some point the US will either reform entitlement programs or raise future taxes to pay for them. Reducing entitlements would help keep more workers in the labor force and more dollars in the private-sector, which would help boost future GDP growth.

By contrast, higher future taxes would put us on the same path as many countries in Europe, with a huge size of government. This creeping Europeanization of the US would suppress future work, saving, and investment. Worse, the process would be gradual, and much harder to notice than a tidal wave of interest payments. The frog gets boiled, slowly.

While most investors are focusing on the straightforward issue of whether debt payments due this summer get fully paid, wise investors need to keep their eye on the key long-term issue. That’s what we are watching. Will politicians make progress on limiting future spending? If not, the long-term growth path of the US will continue to slow.

Ron’s Market Minute — Pundits to Throw in the Towel?!

I ran across the following quote this week. Somehow it seems appropriate at the moment. As G.K. Chesterton wrote in his 1908 book Orthodoxy:

“The real trouble with this world of ours is not that it is an unreasonable world, nor even that it is a reasonable one. The commonest kind of trouble is that it is nearly reasonable, but not quite. Life is not an illogicality; yet it is a trap for logicians. It looks just a little more mathematical and regular than it is; its exactitude is obvious, but its inexactitude is hidden; its wildness lies in wait.”

Markets are becoming MUCH more interesting. Negative stories have been spun in the media all year. After all, we have potential recession, inflation, war, the Fed, and now the headlining debt ceiling. But wait, there’s more! The latest pundit topics have stressed the ‘extremely narrow’ rally with only a handful of stocks accounting for MOST of the gains so far this year in the S&P Index.*

And meanwhile, most of the big money has been defensive while many individual stocks have powered ahead this year. As the major indexes break higher (Nasdaq and this week the S&P) I believe many of the pundits will throw in the towel and move to the positive side of the ledger. This happened in 2009, 2013, 2019, and 2021 after major bottoms.

Don’t get me wrong. All is not peaches and cream, it rarely is. The high yield markets, which are my favorite early warning signal for market liquidity, COULD be acting a whole lot better. And the concerns in the banking industry are well known.

This week’s continued advance in the tech industry stocks is (of course, and with good reasons) suspect, and probably doomed (again by the pundits) to fail. However, whenever market attention is so widely focused on one particular relationship, or sector, it is usually wiser to contemplate a different outcome. And we DO need to give some time for the broader market of tech stocks to catch up to the soaring stars so far this year.

With the trend in technology stocks broadening, it looks like we may possibly be getting closer to a point in which the media ‘experts’ could toss in that towel and become market bulls. Feels like it’s about time.

Ronald P. Denk, CFP®
Investment Advisor
Denk Strategic Wealth Partners
10000 N. 31st Avenue, Suite D406A
Phoenix, AZ 85051
Phone (602) 252-8700
Fax (602) 252-8701
Toll-Free (877) The-Denk
www.denkinvest.com

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