This note discusses four investment controversies that are concerned with market structure. We want to get away, in this note at least, from the headline issues of the next step of Fed policy and market direction. Instead, we focus on structural issues that have a very real impact on key investment decisions that allocators need to make.
The issues cover fiscal sustainability, equity-market concentration, public versus private assets and de-equitization. Fiscal largesse, with its consequences for public debt, is here to stay in the US, regardless of who wins the election. Both that and de-equitization represent a twin levering up of the system by governments and corporates.
These issues are key determinants of the investment-opportunity set, the level of volatility that investors should expect, and hence, asset allocation.
1. “I Still Owe Money to the Money, to the Money I Owe”
One of the persistent themes that pervades conversations with investors this year is debt sustainability. This comes up most frequently in the context of fiscal profligacy in the US and what it implies for debt-service costs. It is, however, a global phenomenon. In Europe, despite a tighter fiscal position, there are nevertheless concerns about sustainability. This is seen specifically in the UK, with the liability-driven investing crisis of 2022, and in France, with the run-up to the 2024 election.
Tactically, the fiscal position supports near-term growth in the US. Strategically, however, it raises a number of concerns. There is no theoretical limit to how high debt levels can go (Japan, after all, surpassed the levels in other developed nations some time ago). However, the future path of interest expense as a share of government spending implies that there are constraints in the future. We hear views expressed in meetings about the risks of this situation for bond markets, although there is no sign of an issue in US debt auctions. We do think that, when outlining capital-market assumptions, it is a reason to expect a higher level of volatility than the norm of the post–global financial crisis era.
There is a broader angle here, too. The extended period of financialization since the 1970s, which included the growth of public debt, provided huge support for financial assets relative to real assets. But alongside the contemporaneous force of globalization, the benefits were unevenly shared. It thus seems appropriate to title this section in reference to a song from indie group The National. This is not only because of the obvious hint at indebtedness in the lyric that titles this section but also the underlying worry about the social fabric. The leverage in the public sector was taken on to engineer growth, which did not benefit all. It was possible to get away with this levering up because of the large forces that suppressed the cost of debt in recent decades (including demographics, the opening up of China and an apparent need to avoid paying for negative climate externalities). However, those forces have now run their course and cannot be relied on to continue. That lack of a cushion is concerning if an already damaged social fabric is set to endure a sustained period of lower growth.
