Covenant Weekly Market Synopsis as of April 15, 2016

April 18, 2016

The past week was a good one for risk assets with global equities appreciating more than 2.5%.  Japan led the way with a gain of 7% (+0.5% MTD), Europe rose by 3.5% (+1.7% MTD) and though U.S. Equities lagged their international counterparts, they increased by a respectable 1.6% (+1.1% MTD).  In spite of the general risk-on sentiment, the price of U.S. Treasuries barely budged as weak inflation data from March will put less pressure on the Fed to raise rates when the meet later this month (April 26 & 27).  Gold gave back some of its recent gains, declining by 0.5%, whereas Silver jumped 5.6%.  The price of WTI Crude continued its upward momentum, gaining 1.8% for the week (+5.5% MTD).  The VIX Index (sometimes called the “Fear Index”) declined by 11% during the week to 13.7, indicating that investors anticipate further gains in risky assets.   Detailed asset class return data is attached here.

Law of Diminishing Returns I:  During the 45 years leading up to the turn of the century, it took about $1.70 of nonfinancial debt to generate $1.00 of GDP.  Since 2000, it has taken on average $3.30 of nonfinancial debt to generate $1.00 of GDP   Non-financial debt includes household, business, federal, state and local government debt.

Law of Diminishing Returns II: In 2015, Nominal GDP (the broadest indicator of economic performance) rose by $549 billion, while nonfinancial debt increased  by a staggering $1.9 trillion, I.e 3.5x faster than GDP last year. The diminishing returns on debt indicate one of two things, or perhaps both:

  • The debt is not being used for productive purposes (e.g. Corporations issuing loans to increase stock buybacks may be good for the price of the stock, but it is not an economically productive use of capital);
  • Excessive debt levels in an economy constrain growth, rather than enhance it.  Total debt is now 370% of GDP, well above the critical level of 250% – 300% cited by academic studies as the threshold at which debt begins to slow economic activity.

The U.S. Is better off than other developed economies considering that the Eurozone’s total-debt-to-GDP ratio is 457% and Japan’s is 615%. The indebtedness race is not one that we want to win – witness Japan’s anemic growth rate over the last 20 years.  All is not lost as the U.S. economy is not predestined to follow Japan.  However,, the longer we delay making the difficult decisions to reduce debt the more intractable the problem becomes.  (Data provided by Hoisington Investment Management).

Be well and godspeed,