The dust has settled on the US debt ceiling dispute. Investors have turned their attention elsewhere and appear to be oblivious to the fact that the issue will come up again in the next 18 to 24 months. Over the next few years, the US national debt will rise from over 32.5 trillion US dollars at present to around 40 trillion US dollars.
Despite the rising debt levels, the US Federal Reserve (Fed) raised interest rates by a further 25 basis points to 5.25% to 5.50%. The overall US yield curve (1 to 30 years) is between 3.95% (10 years) and 5.08% (1 year). We are therefore a long way from a low interest rate environment and refinancing the aforementioned 32.5 trillion US dollars is becoming increasingly expensive. Debt service has risen sharply over the past 12 to 18 months due to the higher interest rate environment. According to the St. Louis Fed, it has already reached 969 billion US dollars (Q2 2023) and is expected to exceed the mark of 1 trillion US dollars for the first time this quarter.
At first glance, the absolute amount the US pays in interest each year is huge, especially when compared with something "tangible". The world's longest tunnel, Switzerland's 57-km-long Gotthard Base Tunnel, cost almost 15 billion US dollars to build. In comparison, the annual interest payments on US government debt are 65 times higher. But is the comparison with a railway tunnel in the Alps meaningful at all?
In my view, it would be unprofessional not to look at US interest payments in relative terms and compare them with something meaningful. Gross domestic product (GDP) is often used for a comparative analysis. If you put the value of the US interest payments in relation to US GDP, it amounts to less than 4% of the US economy. Historically, the figure was higher in the 1980s, at 5%.
Experience shows that it is more useful to compare interest rate payments with total government spending, i.e. to look at the share of debt service in total budget spending. Using the latest figures that number comes in at just 15%, but that is still more than 50% higher than before the pandemic. In the late 1980s and early 1990s, it peaked at 22%. In today's environment it is only a matter of time before these figures are reached again.
The bottom line is that the US government is living beyond its means. I am sure that debt and interest payments will play a major role in the 2024 US election campaigns. The debate about the US dollar as the world's reserve currency does not make it any easier for the US to finance its deficits. It is possible that international investors in particular will expect higher yields on their exposure to US government bonds in the future. In an environment where the US dollar remains expensive in purchasing power terms and the US debt situation is unlikely to improve in the coming years, the greenback will tend to weaken over the medium to long term.
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Reference regarding valuation rates
Unless otherwise stated or specified, the rates used in the analysis are normally the share prices provided by the news agencies Reuters and/or Bloomberg at the close of the stock exchange of the domestic market of the analyzed security or the relevant principal market of this security on the respective local stock exchange on the eve of the day of compilation.
Explanation of investment recommendations for stocks
We apply a “hybrid approach” (internal fundamental analysis combined with “theScreener”, an external, purely quantitative analysis tool). TheScreener is based on purely quantitative, i.e. computable variables such as (but not exclusively restricted to) profit adjustments of the past few weeks, stock valuation in relation to historical performance and comparison groups, the technical trend, performance in relation to the market etc. The assessment of the equity analysts, which is largely based on a qualitative analysis, does not need to match with the one of theScreener. For the overall judgement the assessment of the equity analysts overrides the one of theScreener. LGT Bank (Switzerland) Ltd. categorizes its analysis recommendations into five ratings: for a “Buy” recommendation we expect a relative outperformance compared with the sector. Only equities subjected to an internal fundamental analysis can be rated “Buy”. The recommendation “Attractive” is used for equities exclusively ranked by theScreener without any internal fundamental analysis as “slightly positive” or “positive”. A moderate relative outperformance versus the index is expected. For equities that we rate as “Hold” we expect a performance largely in line with the one of the sector. This can comprise both equities for which a fundamental analysis has been carried out as well as equities that theScreener ranks as “neutral” versus the index. The recommendation “Unattractive” is used for equities exclusively ranked by theScreener without any internal fundamental analysis as “slightly negative”. A moderate relative underperformance versus the index is expected. By contrast, “Sell” recommendations are based on the expectation of a relative underperformance compared with the sector. This can comprise both equities for which we are recommending “Sell” for fundamental reasons as well as equities that theScreener ranks as “negative” versus the index. Therefore the ratings always reflect a relative consideration versus the sector and/or specified index. The risk assessment is based on the individual judgement of the analyst (e.g. we assume a “high” risk for illiquid shares, highly indebted companies or shares from developing countries).
Reference regarding share valuation basis: The analysis compiled by LGT Bank (Switzerland) Ltd. are essentially based on secondary research relating to fundamental and quantitative analysis. Generally accepted valuation methods (valuation multiples, return figures, sector comparisons, comparisons with past valuations etc.) are used for this. The forecasts for the quantitative analysis are prepared with the help of mathematical-statistical procedures (see statements above concerning the analysis tool “theScreener”). Economic indicators such as interest rates, currencies, commodity prices and assumptions relating to the economy are included in the overall assessment. The mood of the market also affects the company valuation. Moreover, many of the approaches are based on estimates and expectations that may change quickly and without warning, depending on developments specific to the industry. Therefore, the recommendations derived from the analysis can also change accordingly. The investment judgements generally refer to a period of 6 to 12 months. However, they are also subject to market conditions and represent a snapshot of the situation. They may be achieved more quickly or more slowly or be revised upwards or downwards.
Explanation of investment recommendations for bonds
We employ both qualitative and quantitative methods to derive our recommendations, which are to be seen as relative to sector/quality peers among comparable maturities. “Buy” and “Sell” recommendations demand a qualitative in-house analyst opinion, in which we incorporate both historical and projected financial results and credit metrics as well as past and anticipated company and sector-specific observations and trends. We recommend “Buy” for a security for which we expect a strong relative outperformance compared to sector/quality peers among comparable maturities. We recommend “Sell” if we expect strong relative underperformance compared to sector/quality peers among comparable maturities. The ratings “Attractive”, “Hold” and “Unattractive” can be based purely on a quantitative approach, which includes the market price of credit risk, valuation of equities and associated instruments, corporate leverage, liability structure, size, and agency rating. We recommend “Attractive” for a security for which we expect a relative outperformance compared to sector/quality peers among comparable maturities. We recommend “Hold” if we expect an average performance compared to sector/quality peers among comparable maturities. We recommend “Unattractive” if we expect a relative underperformance compared to sector/quality peers among comparable maturities.
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Definition of rating categories of S&P and Moody’s which are relevant for us:
AAA/Aaa: Borrower with highest credit quality. Default risk also virtually negligible over the longer term
AA/Aa: Safe investment, default risk virtually negligible but more difficult to assess in the longer term
A: Safe investment as long as no unforeseen events impair the overall economy or sector
BBB/Baa: Average investment. However, problems must be expected if the overall economy deteriorates
BB/Ba: Speculative investment. Defaults must be expected if the economic situation deteriorates
B: Highly speculative investment. Defaults are likely if the economic situation deteriorates
For more information on our methodology for bonds, please contact your LGT relationship manager or your local LGT Group company.
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All selected third-party funds are subjected to a thorough quantitative and qualitative analysis process prior to inclusion in the LGT FundGuide. Selected third-party funds are also subject to a continuous monitoring process. Austria: Investment decisions should only be made on the basis of the current KIID and valid prospectus following consultation with an expert.
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