Debt, Deficits, and Investing

Welcome, everybody, and thank you for joining "The Informed Investor." Today's topic is national debt, and the implications it may have on our stock portfolio. I'm Mark Gochnour, I'll be joined today by Wes Crill and Jake DeKinder. Guys, you had your coffee, you ready to go today? Still working on it. You know, early on a Monday morning, but caffeine's definitely helping. And talking about debt really gets me worked up, so very excited. I was gonna say, Gochnour, can we talk about something happy on a Monday morning occasionally? Well, you're always ready to go, Jake. All right, I'm gonna read a few headlines, like to set it up, and then we'll come back and get your thoughts on this. So two headlines here we're gonna start with. The first one, "US Deficit Fears Cause Stock Market to Dip." And then the second one, "The Tax Bill Could Add to the Deficit and to Stock Gains." So, guys, kind of an interesting kind of contradictory comment there. But listen, we just got passed the One Big Beautiful Bill, and that's led to a lot more conversations around our debt level and the deficit that goes with that. So let me just open up, Jake, we'll get your thoughts on this as we start it out. The headlines are really interesting to me in that it really is, that's a market for you right there, right? People are trying to look for this information and say, "Okay, I see what's happening with the debt and therefore this is what's gonna happen with the stock market." And just in those two headlines, people don't have a clue what's gonna happen with the stock market based on that one variable. So I think the headlines quite frankly are spot on, and that's what makes a market. Yeah, people think that, okay, they hear bad news, they're accustomed to correlating that in their mind with market performance. It might always be clear. I mean, there might be some mechanisms through which, you know, heightened government debt could lead to poor stock market returns. But as we're gonna see, the data that we're gonna talk about later, it's not always been the case historically. All right, well, let me I guess center the conversation on where we are in the US today, and then I'll get your thoughts on some of this and some of the concerns that people have around our debt levels. So we are now at $37 trillion, and by that I'm talking about the total federal debt level. Last year's fiscal year in the US we had a $1.8 trillion deficit. I believe that was the third highest deficit we've ever had, which I think for many people that's concerning when we're not in a period of a war or, you know, major financial crisis. The other thing that's notable is I believe the last fiscal year was the first year we had where debt service, the interest expense crossed $1 trillion. So, you know, a lot of concerning things there. How do most I'll say investors, what are the things they're concerned about when they start hearing debt levels, you know, get to that point? Yeah, I guess on the surface you might think, okay, well, you know, the higher those debt levels, maybe there's a push on interest rates, so borrowing cost can increase for companies. You could have less, you know, private spending. And so all of these things can impede the ability for companies to generate cash flows. And if that's the case, you could have an impact on markets. But I think, you know, you go back to the fact that this is in the headlines. If it's something you're reading about, then it might not be actual news, and I think that's where people need to be careful of, okay, you might have a pessimistic view of where things are headed. That's not the same thing as having a pessimistic view on market. Yeah, I mean, it's a great point. You know, when you put your investor hat on, you really have to push yourself and say, "What is it that I think that I know that isn't out there?" And if you're reading the headlines and everybody's chatting about it and we say it all the time, people know about it and it's in the price. It's been baked into the expectations for what we think is going to happen to markets going forward. Well, let's look at then the impact perhaps in the US, you know, going back to the idea of this debt level just increasing and increasing, what's been the impact on stock market returns here in the US? And if you go back, there's been really two major, major increases in our national debt. And by that I'm talking about debt as a percentage of GDP. We saw it coming out of the financial crisis in '08 and '09 and then we saw a huge increase in COVID. So if you go back to the beginning of 2008, debt as a percentage of GDP was about 64%. Today, it's about 121% or so. Yet it was interesting over that time period, and I wanna look at my notes here just to make sure I got the right number. The return of the S&P 500 during that time period was 10.7%, yet the last five years, even with this massive increase in debt was about 14.5% or so. So you don't necessarily see a negative impact like you might expect when debt levels increase at a really high velocity. So I know, Wes, you've done a lot of work on this as well. Maybe from I'll say a more research perspective, what's some of the things that you found when looking at that? Yeah, one thing that's notable is that, you know, you mentioned the increase in debt of recent years. We're not alone when it comes to that. In fact, we have a sample of about 20 countries that report their debt statistics to the database, and we see the 8 of these 20 countries actually have debt to GDP over 100% like you just mentioned for the US. And it's not really clear that there's a threshold beyond which if a country is carrying a certain level of debt, that their whole economy collapses because they failed to meet their financial obligations. You've had some countries like Argentina, like Ivory Coast where they defaulted on their debt with debit to GDP well short of 100%. Whereas you've had other countries like Japan who have carried in 200% of the GDP for a number of years. But I think my favorite country for these stats and for many things in this world, you know, like chocolate is Belgium. So you look over this 49-year sample period, well, Belgium's had a debt to GDP of at least 100% in 34 of them. And in those 34 years, their average calendar year return was over 15%, which was higher than the global market return over that stretch. So, you know, again, this is classic, whenever we look at these macroeconomic variables, whether it's debt, whether it's GDP growth, inflation, things like that, we tend to see that when you plot out a country's return and contemporaneously with that variable, you do not see a strong relation in the data. Is that because the market doesn't care about this stuff? Certainly not, but it's because they're likely pricing in these variables. Well, it's a good point about the market not caring about it. I mean, I hear people say sometimes, "Hey, like whatever the level of debt is, it doesn't matter for stock market returns." I don't know if that's the case, right? It is relevant information. It is baked into stock prices. The question is, is does it give you information above and beyond? Does it give you a predictive power so that you can say here is what is going to happen with the stock market? And therefore that's how I should adjust my plan. And this gets to the classic thing we talk about all the time, which is separate you as the citizen of a country from the decisions you make as an investor. You know, I've got kiddos, I think about the future, I wonder what's gonna happen with the debt, what's it gonna mean going forward for taxes and many implications, right? And as a citizen of a country, I see some decisions that maybe don't make me completely happy. But as soon as I let that carry over to now I'm gonna start moving my money around, that's where I get into trouble. I think that's really the key point, Jake. You gotta separate your personal feelings around this, which you should have strong feelings Right. About where we are versus what you do with your investments. And it goes back to the research you just cited there. There's no real research that suggests somehow a change in debt levels necessarily means bad things for your stock market. Now, does it impact the stock market? I would say absolutely. But it's one of thousands of things that are part of that. So you can't really necessarily isolate it just to one particular topic. Yeah, that's a key point is all the other drivers of market performance, you see this, you know, we've said now three major rating agencies downgrades of US sovereign debt. And we looked at an indicator around those periods of time where credit default swap spreads. This is basically the insurance to protect against, you know, a missing of debt obligation for the US. And when we look at that price, that spread for the CDS, we really see minimal impact around these downgrade events, whether it was in 2011, whether it's 2023, 2025. And that would suggest that the market really wasn't learning anything new when these downgrade events, which were articulated as being related to mounting government debt for the US, we really don't see much of a movement there. In fact, '23 was a great example to the point you're making, which is you did see a big spike in the credit default swap spread for the US but it was earlier in '23, it was actually during the regional banking crisis. So, again, to your point, there's lots of things that are gonna impact markets, not necessarily just one macroeconomic variable like this. I think the 2011 example is interesting. That first time that we saw arguably the safest debt in the world get downgraded. What you saw was, that was in August, and you actually saw the stock market drop, right, in August. We saw a little bit of a drop there, but you actually saw a rally in treasuries. And so it was interesting, you know, if you went to people at the beginning of the year and said, "Hey, here's what's happened. We're gonna get downgrade in the US debt, what do you think is gonna happen with the returns of US debt?" There's not a lot of people that said, "Oh yeah, we would've seen big rally in treasuries during that year." You just don't know the way markets are gonna react. And you go back to those downgrades, it was 2011, 2023, and then just recently 2025 by the three large rating agencies as well. But go back to the point of it's in the price, you know, because you made a comment that you just didn't see a real reaction there when the debt was downgraded because it was sort of anticipated, right? All this information, you guys talked about that earlier, it's already in the price. When we say it's in the price, it's not meant to be flippant. It's basically saying that this is a pretty slow moving statistic, the debt-to-GDP ratios, and that if you have a slow moving variable or something that investors or market participants have information about, they can form expectations around it, they're going to set prices accordingly, such that if it comes to fruition, no matter how pessimistic the expectations were, but if it comes to fruition like that, you can still have a good outcome from markets. It's also interesting too when you consider this concern that you have. I mean, again, you come back as an investor, like, what is it that you have control over? And we were talking about this before we go on, again, we're not making a prediction that here the US debt is increasing, therefore the US is gonna have bad stock and market returns. But it does come back to basic concepts around, yeah, you globally diversify across countries, right? You have things that are in your control. And you mentioned taxes as well. Again, we're not here to make a prediction on what's gonna happen with tax rates, but if you think about the debt, there's only a couple ways it can come down. If you do have concerns about that, now let's get into a planning discussion. Let's think about what you actually can do with your money. Let's think about asset location. So you don't have to feel helpless when you read about these things, right? You do have decisions that are within your control. Just realize that, be careful making some of those decisions of moving your money around based on, "I predict this is what's going to happen." Well, and another thing I wanna highlight, just going back to some of the research too is we're gonna hear all the time, "Hey, it's a first time since," or "It's the biggest record ever," you know, in terms of maybe debt levels or things like that. But, you know, we've talked about this before. You look at, there's no magic number that you really can manage to say, "Hey, here's the optimal dollar amount of debt level," or "here's the optimal amount of debt as a percentage of GDP" because there's so many factors there. You might have an increasing debt, but that's potentially okay as long as your economy's growing. So there's no real way to assess, here's the optimal number for that stuff. No, it's a great point. I think that's why, you know, figuring out what that threshold could be, it's really hard to know. And, again, it's just gonna be one of many things that, okay, would you prefer to not see it go up? Sure, in an ideal world that would be the preference. But it's only gonna be one of many things that occurs in the future. Hopefully some of those are good enough to offset the pejorative of rising government debt. All right, so my takeaways. A lot of research has been done around this. You can't necessarily say, "Hey, this debt level means this," or negative things really, "to my stock portfolio." It's one of many things that falls in there. Whatever you're worried about with that, it's already reflected in the price. If we read about it, we're aware of it that way, the market's aware of it and it's in the price. And, Jake, I like what you said there. So control what you can control, right? Diversify your portfolio. Focus on those areas where you can be tax efficient if that's a need for an investor. And don't make I say emotional decisions. Separate what you're concerned about from what you do with your investments. One other point there, and I think it's the title of this show, is it doesn't mean you don't stay informed, right? You want to be informed on this stuff. You wanna be able to know what's going on with it. You want to have specifics on what's taking place in that bill. It's just don't let that sort of transition over to drastic changes with your plan. All right, now, Wes, you mentioned a couple different works that you guys have done, some research down here. Let me just highlight them for the audience here because if you go down to show notes, you'll be able to see some of the links to these different papers. So here's the ones you wanna be on the lookout for. "Country Debt and Stock Returns, " "Not News If Not New," and the "Moody Blues," which gets into then Moody's downgrade of the US debt in 2025. So check out those links. And, again, what we've been focusing on here today and going forward are looking at, is there any economic signal that's out there that might tell us something about what stock market returns may do into the future? So we're gonna continue that in the next episode and take a look at our economy and GDP growth and see if that gives you an indication of future returns in the market. And be sure to subscribe to "The Informed investor" on YouTube and enable notifications so you know when we have updated episodes. Thanks for joining today and have a fantastic rest of the day.