“Today the risk premium in equity USA stands around at 5%while the difference between the expected stock return and the 10-year bond yield is ai lowest since 2008, just above 1%. In these conditions, they are bonds are more attractive, because they offer expected returns similar to those of stocks, but with reduced volatility.” This is the analysis of Alberto Conca, manager Zest Asset management Sicav and investment manager Lfg+Zest. The weakness of the US stock market is linked to a series of key factors for the US economy: first of all the high public debt, but also demographic trends, interest rates and company profitability.
The weakness of US public debt
“As for the public debtthe US government is spending at unprecedented levels and, according to our analysis, this will drive the ratio debt/GDP to 165% by 2035: with these numbers it is logical to assume that a moment of tension or fear on the financial markets, caused by the enormous accumulation of debt, is no longer a question of if, but of when”, Conca points out.
Another fact that highlights the unsustainable trend of American debt is the nominal growth of debt compared to that of GDP: the former stands at 9.12%, while the latter is at 5.97%. What is more Of concern is the cost of debt servicing, i.e. the interest that the US government pays annually on its debt: in the 1980s and 1990s, when interest rates were above 10%, interest expenses represented 21% of government spending. Today, with a average cost of debt around 3%, the burden of interest is 16% and a simple US rate increase of one hundred basis points would bring us back to those levels. It is now imperative that this budget item is controlled before it becomes unmanageable. A third variable to consider is the maturity of the currently issued debt. Half of the debt is due to mature within three years, meaning that if current interest rates remain at this level for an extended period, the cost of servicing the debt will likely rise towards 21%, if not higher.
The “debt multiplier”
Fourth element to take into consideration is the “debt multiplier”, which describes the number of units of GDP generated by one additional unit of debt. Since 2003/2004 it has been the efficiency threshold has been exceeded, according to which 1 unit of debt generates 1 unit of GDP. Today, each unit of debt creates less than 60% of that unit in terms of GDP and this means that increasingly larger amounts of debt are needed to increase GDP. Fifth point, given that growth decreases as the debt/GDP ratio increases, in the long term we believe that GDP growth will normalize to lower levels than those recorded so far and, consequently, stock valuations will be negatively affected.
Workforce and productivity
In addition to debt, others two drivers important for the development of the country are of workforce and the increase of productivity. The five-year population growth rate since 1991 has fallen from 1.35% to 0.5%, so the potential growth of the United States it's decreasing also due to the slowdown in population growth, despite the positive impact of immigration. As for American productivity, the growth rate from the 1960s to today stands at 1.31%. By adding population growth (0.5%) and productivity growth (1.31%), we can state that the growth of the United States described by these two variables is slightly less than 2%.
“Considering the main drivers of economic growth in the United States and the performance prospects of the S&P 500, starting from current valuations, we can state that the preferable asset allocation should favor government bonds or corporate bonds”, concludes Conca. “Should stocks go through a period of volatility and some late correction, there will be scope to increase equity exposure. For now, corporate bonds and government bonds offer a superior risk-adjusted return profile.”
