That huge federal debt is so bullish

There is a lot of discussion of “cash on the sidelines” and what that might mean for the outlook for risk asset prices.

To me, that entire discussion is a rabbit hole drilled through with unknown unknowns.  It reminds me of something an econometrics prof said to me in undergrad when I was trying to force him to look at it my way, so I could resolve a puzzle in my own mind.  If you want to have any chance at all of understanding this, you are going to have to first clear all that shit out of your head. Ouch.

So, I ain’t going to get sucked into this discussion, except to make three points, two of which are sort of factual and the third of which I am not going to argue with you about.  Let’s say I will leave the proof as an exercise for the reader!

First, this cash on the sidelines argument has been around for a long time. On the other hand, the equity market has been going up for a long time. So what do I know?

Second, when people are talking about cash on the sidelines, I think that the main thing they are saying is that the average portfolio is not particularly risky. The only serious treatment I have seen of that issue was put together by Jesse Livermore at Philosophical Economics.

Jesse claims that a low-risk average portfolio is a good predictor of subsequent returns, but he does that largely in jest or to make a point about data mining. To me, the valuable part is his rigorous take on what we mean when we say people are “underinvested”, in cash, or whatever.  Most other discussions of this are poetic, as Bloomberg demonstrated again today.  No link. I link to Bloomberg too much.

Finally, there is my point that may strike you as more argumentative.  You know, it would have been very difficult for investors collectively to rebalance towards holding a higher stock of low-risk assets, without the effort being entirely self-defeating, were it not for the steep rise in the stock of low risk government securities, sometimes called the federal debt.

I won’t try to argue this, because my experience is that it makes people’s eyes glaze over.  Plus I might be wrong.  But here is a hint. Government debt has to finance something, and the market value of securities owned is the market value of securities issued.  Also, think in terms of net, to avoid double counting. Starting with Jesse might get your head in the right (by my lights) space on this issue.

Anyhow, assuming I am right, which I may not be, I find it piquant that with the equity market having tripled, people are insisting – indirectly and unwittingly – that the accumulated federal debt is bullish.

I think they are right, about this taken in isolation. But the old view was that the deficit was a short-term fix and that the associated debt overhang would be a long-run negative.  At 2100 on the S&P, this has switched.

That is fun.