Piquing Interest in US Debt

Lately we’ve seen some chatter about higher interest rates, suggesting rising interest costs could cause a US “debt spiral” and undermine our financial system. Data, however suggest otherwise—even with interest rates up a bit, US debt remains very affordable by historical standards and shouldn’t put this bull market at risk.

US debt interest costs are historically low—about half what they were during much of the 1980s and 1990s, which were fine times for stocks. Higher interest rates don’t immediately change this—they impact newly issued debt only. And even with the recent uptick in rates, the 10-year US Treasury is still ultra-cheap at 2.5% (as of market close on 7/3/2013)—the slightly pricier debt issued today doesn’t much impact our total debt service burden. In order for US debt interest costs to rise significantly, we’d need to see interest rates rise substantially higher and stay there a long while—the average maturity of outstanding US debt is about 5 years, giving plenty of breathing room.

That’s not to say the US’s fiscal situation is perfect—endlessly piling up debt would be a negative—but near- and medium-term risks appear minimal, which is what matters for equity investors. Markets typically look about 12 to 18 months ahead, and we don’t see a catalyst for runaway debt interest costs during this period. The US is still one of the most attractive investment destinations globally, and there’s ample demand for assets backed by the full faith and credit of the US Treasury. We have the world’s deepest, most liquid capital markets and a strong economy backed by the rule of law and clear, well-enforced private property rights.

So US debt fears likely won’t much impact stock markets—instead, this bull market should keep moving higher on the back of very strong fundamentals. Corporate earnings are at all-time highs and rising. The Leading Economic Index, too, is high and rising—recessions don’t typically start until the LEI has deteriorated for some time. Housing’s still growing, providing a small economic tailwind. Equity valuations remain pretty darned low by historical standards, suggesting investors haven’t started bidding up shares the way they typically do during a late-stage bull markets. And with investor sentiment still seemingly split between skepticism and optimism, there’s lots of room for reality to exceed expectations and lift markets higher.