US Interest Rates Going Higher How This Affect Investment?

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Hi Tiger for the past 2 week, I opened Bloomberg and noticed a flurry of headlines about rising interest rates, crashing markets, and the bond market taking a hit. To top it off, Ray Dalio warning about the possibility of the U.S. government going broke and offering strategies to prevent it.

The Debt Cycle

In this article, I want to delve into the debt cycle, interest rates, debt sustainability, and Ray Dalio's assertion about the U.S. government's financial struggles. We'll also discuss the market's growing awareness of interest rate impacts and what this means for us as value investors. Let's dive right in, starting with Ray Dalio's perspective on the U.S. government facing potential insolvency.

Dalio recently shared some excellent insights, including three chapters from his upcoming book. Until about a week ago, everything seemed to be going well—strong economic growth and solid job data. However, Dalio notes that during this phase, markets and economies appear robust, and borrowing drives growth, creating wealth seemingly out of thin air.

But this wealth isn't entirely real—it's often an illusion of growth fueled by debt rather than tangible economic expansion. When this bubble bursts, we face a self-reinforcing contraction of tightening monetary policies and unsustainable debt growth.

Historically, policymakers have intervened, as they did in 2009, by adding more debt to stabilize the system. However, this approach only works until the capacity to incur additional debt is exhausted. At some point, inflation or a loss of faith in the currency prevents people from accepting the same wages for their labor. This marks the limit of debt creation, forcing a painful realignment of debt with real income, triggering an economic downturn.

For now, economies are growing above their productivity lines due to increased debt. However, this overgrowth will need to be balanced by periods of undergrowth. Economic growth in recent years has been largely fueled by rising debt levels.

A fascinating article by Jesper Rangvid, a finance professor at Copenhagen Business School, compared the debt-fueled growth of the U.S. to the Euro area. While both regions experienced moderate growth in the early 2000s, the U.S. surged ahead after the housing bubble, supported by a sharp rise in debt-to-GDP ratios. In 2007, U.S. debt-to-GDP was 45%; today, it's nearly 100%.

Government spending often boosts economic growth, with each dollar spent generating between $0.20 and $2.50 in additional growth. However, the critical question is: How sustainable is this model? How long can we continue borrowing and spending recklessly, as Stanley Druckenmiller might say, "like drunken sailors"?

The Congressional Budget Office's (CBO) projections for the next decade provide little reassurance. Spending is expected to rise, with deficits projected to remain at 7% of GDP indefinitely—a level widely considered unsustainable. Deficits have already climbed from 30% of GDP in the early 2000s to 70%, and much of this borrowing is now used just to cover interest on existing debt.

When a government relies on borrowing to pay its interest obligations, it’s a clear warning sign of unsustainability.

Debt becomes unsustainable when you reach the point of paying interest on interest—essentially, compounding. This is a concept we, as investors, focus on closely. There’s a limit to how much debt an economy can sustain—120%, 150%, or 200% of GDP—before something has to give. Until that breaking point is reached, there might still be some room to maneuver, but this cannot go on indefinitely.

Interest Rates & Bond Yields

The market is starting to take notice. According to Bloomberg, global bond markets are under pressure. Interest rates on 10-year U.S. Treasury notes have risen from 3.6% to nearly 5%, and some speculate rates could stabilize at 5% or even climb higher. Concerns over debt sustainability are spreading globally, from the U.K. to Japan. In the U.S., 30-year mortgage rates are hovering just under 7%, weighing on housing purchases and contracting housing demand. This, in turn, dampens spending and could eventually lead to a recession.

Historically, rising 10-year yields have foreshadowed economic downturns and market disruptions, such as the 2008 financial crisis or the bursting of the dot-com bubble. Despite this, Wall Street economists are hesitant to predict a Federal Reserve rate cut anytime soon. With the labor market performing well, it seems unlikely the Fed will lower rates in the near future. Instead, we might be facing a prolonged period of higher rates, especially as politicians show little appetite for fiscal tightening.

This environment creates a challenging backdrop for bonds. Long-term bonds are now associated with poor returns, prompting the emergence of a risk premium that hasn’t been seen in over a decade. While bonds previously delivered negative real returns, the "new normal" may involve yields stabilizing around 4%—or even climbing to 7%, which would significantly impact markets.

Several structural factors further complicate the picture, such as globalization, aging populations, political instability, climate change spending, and the rising cost of servicing debt. Investor concerns about deficits have intensified, especially under political pressures like those brought by Trump. Analysts, like Ed Yardeni, suggest that yields could hit 5%, but the implications remain uncertain. Yardeni also recently predicted the S&P 500 could rise to 5,000 in this environment, though his previous claim of 7,000 has already been walked back.

What’s striking is how long it takes markets to recognize and respond to these dynamics. For instance, Stanley Druckenmiller highlighted the risks of bonds over a month ago, stating he was short bonds. Since then, long-term bond yields have climbed from 3.6% to 4.6%, representing a 25% increase in 30-year Treasuries. Druckenmiller has likely made significant gains on that call.

This reflexivity in the market—where less housing demand leads to less spending, which might eventually prompt the Fed to lower rates—illustrates the cyclical nature of the situation. But lower rates would likely coincide with weaker economic performance and lower corporate earnings.

Ultimately, we’re navigating a landscape filled with uncertainty. Just a month ago, in December, the outlook seemed stable, but now, in January, the situation has already shifted dramatically.

Treasury sell-off, Rising U.S. inflation?

The headlines are dominated by a Treasury sell-off, rising U.S. inflation, and expectations of higher Federal Reserve policy rates. Higher rates are weighing on stock prices, with Asian markets under pressure and Wall Street increasingly worried about the possibility of a prolonged bear market. Rising rates hurt earnings, economies slow down, and yet, stocks continue to decline.

The Fed may eventually be forced to cut interest rates, but lower rates could fuel inflation again, creating a vicious cycle. The root issue is economies heavily reliant on debt, which distorts real market dynamics. Over the past 15 years, interest rate markets have been artificially shaped by the Fed’s policies, taking advantage of globalization and technological advancements to keep inflation low. Now, as we face potential "return to reality," the distortion may begin to unwind.

For investors, Ray Dalio emphasizes that big debt crises are inevitable—though predicting when they’ll occur is nearly impossible. There might still be another leg up in the market, perhaps lasting 5 or 10 years, or new shocks could emerge that we’re not yet discussing.

When it comes to positioning, it’s about managing risk and reward. If markets have another upward phase, you may leave some upside on the table by being cautious. However, diversifying into safer options like bonds or other hedged investments limits both upside and downside risks. This balance of risk and reward is fundamental to investing.

Stock That Affected By Interest Rate

Real Estate and REITs (Real Estate Investment Trusts)

REITs (e.g., Prologis, Realty Income): These are negatively affected by rising interest rates since borrowing costs increase, making it more expensive to finance property acquisitions and developments. Higher rates can also make REIT dividend yields less attractive compared to bonds.

Utility Stocks (e.g., Duke Energy, NextEra Energy)

Utility companies rely on significant borrowing for infrastructure projects. Rising rates increase their financing costs, and their dividends may appear less attractive compared to higher-yielding bonds.

Dividend Stocks

High-Dividend Yield Stocks (e.g., Verizon, AT&T): These can face headwinds when interest rates rise, as bonds and fixed-income securities offer a more competitive yield.

Conclusion

My perspective is that we should invest with a long-term horizon—over a 20-30 year cycle or more—building wealth steadily, brick by brick. Focus on investments that remain valuable regardless of market conditions. For example, essential goods like food will always be necessary, and companies in this space tend to offer stability. These investments might be undervalued now compared to other sectors.

Additionally, companies like Berkshire Hathaway, with a $300 billion cash position, are well-positioned to seize opportunities during a market crash. While its current valuation suggests lower returns, its low risk profile and strong cash reserves make it a solid option for the long term.

The reality is, no one can predict the future with certainty—not the Fed, not Wall Street, not us. Timing the market perfectly is a myth. Instead, we need to prepare for any scenario by finding low-risk, high-reward investments that can perform well regardless of the broader economic environment.

Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.

@Daily_Discussion @TigerPM @TigerObserver @Tiger_comments @TigerClub

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Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.

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