Today's towering debts and deep deficits have arisen as governments borrow heavily to support growth, fund social programmes, and manage interest payments. Although deficit spending can stimulate economic activity, the long-term implications are worrying.
For a start, the economy can grow dependent on ongoing deficits. What the state borrows with one hand it spends with the other, and that spending is income for contractors, government workers, pensioners, and other beneficiaries. Having grown used to government largesse, the economy can struggle if the taps are closed off.
Excessive government spending can also fuel inflation. This is a key concern in the US, where the Trump administration has pledged to keep spending on areas such as border security and defence at the same time as extending tax cuts.
On the government's side, debt and deficits can start to spiral. Every year the state runs a deficit, it must issue more debt to plug the gap in its budget. A bigger debt pile brings bigger interest payments. Bigger interest payments make it harder to avoid deficits, which tend to get worse—requiring yet more debt. The result is an ever-growing mountain of bond issuance for investors to digest, and just like any other asset, the price of bonds is a matter of supply and demand. If the supply of bonds grows too quickly, their price must come down (meaning their yields must go up). Higher bond yields do not make it any easier for governments to manage their debt piles.
What does this mean for markets?
Dependence on debt makes financial markets more fragile, and likely more volatile. Investors may demand higher compensation for holding risky assets, which could mean higher corporate bond yields and a more stomach-churning stockmarket.
So, amid all this excessive government spending, stockmarket investors face a challenging path. In the US, the long bull run in the S&P 500 Index since the global financial crisis has been helped by ongoing deficit spending, low inflation, low bond yields, and plenty of money printing. But if fiscal and monetary conditions shift decisively, the next decade could look very different.
How should portfolios prepare?
Trying to predict the next market move is generally a fool's errand. And in more febrile markets, that's even more the case. So rather than reaching for crystal balls, investors should focus on ensuring that their portfolios are well constructed and sufficiently diversified to prove resilient in different market conditions. A single fund holding a diversified global portfolio of securities across asset classes may serve as a good solution. The Orbis OEIC Global Cautious and Orbis OEIC Global Balanced Funds offer just that. The lower risk of these two – the Global Cautious Fund - seeks to strike a cautious balance between the pursuit of investment returns and the risk of loss through a diversified global portfolio of equities, fixed income and commodity-linked instruments.
When debt is rising and markets are potentially unstable, certain asset classes can act as reservoirs of resilience. These are the some of the areas we're currently finding most compelling.
As an active manager, our primary job is to make decisions under uncertainty, and intelligently assume risk, where we believe that risk is more than adequately accounted for via a depressed price. The ultimate question when purchasing a security is whether it will enhance the portfolio's balance of risk and return.
Companies with attractive dividend yields and strong free cash flow generation, like Kinder Morgan are well-suite to the Global Cautious Fund. And while many of the equities in the portfolio could be classified as "moderate risk", we are also comfortable investing in more volatile stocks – especially if we believe the companies' fundamentals are safer than the market thinks. In our Global Balanced and Cautious Funds, we can hedge equity exposure to target the difference between the return of our stocks and the return of broader stockmarkets. This provides a lower-risk way to remain invested in our most attractive ideas.
Moving across the capital structure, instruments such as US Treasury Inflation-Protected Securities (TIPS) can help safeguard against rising inflation by providing consistent real-return streams.
Global investors have global currency exposures, which bring risks worth managing. With the US dollar looking richly overvalued, we have hedged exposure to the dollar in favour of the Japanese yen, which looks sharply undervalued. Gold is widely seen as the ultimate store of value in uncertain times. It also acts as hedge against inflation.
And then of course, there's our contrarian philosophy. During the long bull market, the virtues of passive investing were widely extolled. But if the market turns, passive strategies have real vulnerabilities – not least because they end up concentrated in whatever did well in the past. As contrarians, we prefer to hunt for ideas in areas that have been neglected amid the euphoria.
Adapting to change
The reshaping of the investment landscape by debt and deficits could be drastic. Noone can predict exactly how this will unfold or precisely how markets will react. But being prepared is key. The Orbis multi-asset funds are designed to navigate different market environments – providing investors with a choice of strategy that adapts to long-term change rather than simply chasing fleeting trends.
Disclaimers
Approved for issue in the United Kingdom by Orbis Investments (U.K.) Limited, which is authorised and regulated by the Financial Conduct Authority. Orbis Investments (U.K.) Limited is incorporated in England & Wales under company number 8138002. Registered office address: 28 Dorset Square, London, NW1 6QG.
The information provided in this document is for general informational purposes only and does not constitute financial, investment, or other professional advice. The content is not tailored to the specific investment objectives, financial situation, or needs of any individual. Investors should not rely solely on this information in making investment decisions. We do not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from the use of or reliance on such information.
The value of investments in the Orbis Funds may fall as well as rise and you may get back less than you originally invested.
