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You may have seen on CNBC or read in The Wall St. Journal that interest rates are rising. The 10-year Treasury spiked to 5.2% this week, the highest since 2007. Mortgage rates jumped to 7%, which may be the new normal.
But what does this all mean? Why are interest rates going up?
The answer to this is a bit more nuanced than you might think. We are talking about a single indicator here—interest rates. But many factors influence that single indicator.
Is the war between the U.S. and Iran a factor? Yes, it most certainly is. Energy prices are inflationary, which pushes rates higher. But is this war the single biggest factor? In my professional opinion, no.
Are rates higher because of the AI boom, signaling a strong economy? Yes, this is also true, but again, I don’t believe it is the biggest factor in why rates are rising.
The primary reason interest rates are rising is the persistent lack of fiscal responsibility Washington has displayed. For decades, we have been borrowing money we don’t have, and that persistent borrowing leads to higher rates. Simply put, our country has done a terrible job managing its finances, and we are now starting to feel the pinch.
Note that this isn’t a partisan issue—both sides have borrowed and spent money they didn’t have.
And this has led to a massive spike in our debt load. Prior to COVID/2020, government debt was at $23T (Q4 2019). We just surpassed $40T.
Today’s annual deficit spending is somewhere near 6% of GDP, which is extraordinarily high, especially outside of a massive recession or war. Our interest payments alone on this debt are $1 trillion this year, more than our national defense budget. And this will keep rising if our debt continues to outpace GDP.
The golden credit card
Howard Marks said it best when he described the enviable position of having the dollar’s position as the world’s reserve currency. The U.S. has had the ‘golden credit card’ to which there is no credit limit and the interest rate is very low.
But instead of using this credit card when absolutely needed (e.g., during a major recession or a massive war), we spent it during market booms and economic expansion. We have been on a drunken spending spree since at least the early 2000s.
Large deficits like this are inflationary, especially when the economy is growing, since the government adds more liquidity through spending than it takes in via taxes. This extra liquidity stimulates economic growth, which fuels inflation and makes the problem even worse.
It’s sort of like that colleague of yours who spends $700k per year when they only make $500k. It can’t last forever.
The number one question
The most common question we get these days is, “Should I sell all of my stocks?”
And our immediate response is, “And do what with them?”
It’s understandable. The market has done extraordinarily well, given higher-than-average inflation, the U.S./Iran war, and stretched stock valuations. The natural temptation is to sell everything and put it someplace ‘safer, with less risk.’
But where would that be? If you want to rebalance your portfolio and take some risk off the table (and to harvest some bond losses, if you have them), that’s one thing. Completely selling out of your portfolio is another.
The problem that we face isn’t a U.S. stock problem. U.S. companies are performing quite well. The problem we have is too much government spending and a potential U.S. dollar problem. And there really isn’t a better place to put your assets.
If you sell your U.S. stocks and leave them in the bank, you still have your dollar-denominated problem (you literally purchased U.S. dollars).
If you sell your U.S. stocks and purchase Treasury bonds, you still have your dollar-denominated problem (Treasuries are priced and traded in U.S. dollars).
What if you sell U.S. stocks and buy international stocks? You are trading one type of risk for another. You now have assets denominated in another currency, probably with poorer growth prospects, more regulation, and less scale.
And keep in mind that U.S. companies have a lot going for them. They operate in an environment of free-market capitalism, innovation, access to capital, a world-class education system, and the rule of law.
And the grass isn’t always greener. Europe is in worse shape than we are. France, for example, has significant headwinds. Remember the 2023 riots when France raised its retirement age to 64? That’s because France has more than $3.5T in debt and no real way to pay that down. Raising the retirement age helps a bit.
The far-right front-runner in next spring’s election wants to lower that retirement age while the far-left challenger wants France’s central bank to simply cancel the debt. All of it.
The European Central Bank can step in to help France out, but it requires strict spending rules. If it can’t do that, bond contagion could create a mess for the entire European continent.
So, U.S. stocks, in my opinion, are still the best bet for this type of environment. Yes, of course, it would be smart to add non-correlated assets to diversify your dollar risk (we have). But as Warren Buffett has said, “Never bet against America.”
