Phasing out of financial repression will affect your investments
The phasing out of financial repression. The United States seems to be in the process of departing a regime of financial repression, i.e. one where a government takes measures to channel funds into its own debt. Overall leverage in the United States has come down from peak levels in many segments of the economy, including the corporate and housing sectors. And while government sector indebtedness is still quite high on an absolute basis, higher-than-expected revenue attainment and modestly lower spending levels have brightened the picture for this segment of the economy. Indeed, the budget deficit as a percentage of GDP has improved markedly over recent quarters and this has required lower levels of debt issuance.
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Market Realist – Leverage climbed to extreme levels during the sub-prime crisis of 2008. This showed the high level of financial stress in the economy. The above graph shows how U.S. leverage has come down. You can see that the NFCI financial and non-financial leverage sub-indices have both reduced.
A U.S. economy slowly emerging from financial repression, coupled with robust credit availability, should continue to allow corporations, especially higher-rated ones, to benefit shareholders through capital structure arbitrage, while not appreciably hurting debt holders. In other words, cheap financing and easy financial conditions can create a framework for equity optimization that allows risk asset prices to grind higher even in the face of what some believe are extended valuations.
Market Realist – With the U.S. economy leaving behind financial repression, now would be a good time to invest in U.S. markets (SPY)(IVV). Large caps (QQQ) and the energy sector (XLE) look particularly vibrant. But stretched valuations in the small-cap (IXJ) and biotechnology (IBB) sectors make them less appealing—at least in the short term.
Read on to the next part of this series to find out how the pace of technological changes could affect the markets.