No Time For Debt
Blessed are the young for they shall inherit the national debt.
There has been rising concern amongst investors and investment strategists about rising national debt around the world as seen from the headlines from Bloomberg, Financial Times, and the like.
The US, with the highest external debt in the world sits at $22 trillion (at end 2020). It was not too long ago in 2011 that US national debt was half that amount at $11 trillion. However, in terms of debt to GDP ratios, it is not the most indebted country in the world as shown by the OECD data below. The average debt to GDP ratio is 80% with quite a number of G7 countries (highlighted) with ratios exceeding 100%.
There is an assumption that a high debt to GDP ratio may cause a country to default on its obligations. Whilst debt to GDP ratio can be one major variable, it is most certainly often not the main cause. Just take a look at Japan; it has experienced over a decade of debt/GDP levels above 200% without defaulting. On the flip side, there are many instances of countries defaulting on their debt with debt/GDP ratios lower than that of many countries today. For example, Argentina defaulted in 2020 with a debt to GDP of only 90% and Ivory Coast defaulted in January 2011, when its 2010 debt to GDP was just 46%. We can see that while debt/GDP ratio can be a significant statistic, it isn’t really a predictor of default prevalence — many other socio-political factors could very well be more pertinent.
The other concern about rising debt is the assumption that the stock market of that particular country will be adversely affected once the bill for this future spending is due. Dimensional Fund Advisors conducted a study on the effects of debt on equity market performance using data from 1975-2018 for developed countries and data from 1995-2018 for emerging countries. The table below shows that the equity market premium (difference of the equity returns minus government bond returns) between a high or low debt country is virtually indistinguishable.
One could argue that perhaps taking on a large amount of debt over a short period of time (similar to what many countries did over the pandemic) may have a different outcome than the one above. The table below shows the results of repeating the analysis using a country’s change in debt/GDP compared to the previous year. In both developed and emerging markets, the results show that even large increases in debt/GDP have not impaired equity markets.
The information presented in this article shows that despite the concerns out there, the indebtedness of a country has no relation to its stock returns. It is likely that investors have already factored in these variables in their valuations. It can also be used as evidence to show how quickly investors and market prices assimilate information — be it debt, inflation, changes in interest rates, earnings, and the state of the economy.
Rather than worry about the myriad of issues that may or may not affect markets, it is best that we look at the things that matter. How much money you need, what concerns you about your personal financial well-being and how much time you have should be in focus. Your time is best served by following a well constructed plan that helps solve all these problems.
