Hedge fund manager Mark Spitznagel is critical of the high level of US debt. The “powder keg” created by the Fed’s policy is likely to explode sooner or later – and take the stock market, which is currently overvalued, with it.
• Fitch downgrades US credit rating
• Mark Spitznagel warns of a credit bubble
• Stock valuations too high
“Erosion of governance”: Fitch downgrades US credit rating
At the beginning of August, the rating agency Fitch downgraded the USA’s credit rating from AAA to AA+ after the country jumped out of default a few weeks earlier. The debt dispute in May prompted Fitch to downgrade the US long-term issuer default rating to reflect “governance erosion,” the agency said. It is the first downgrade of the United States by a major rating agency in more than a decade.
US Secretary of the Treasury Janet Yellen was anything but enthusiastic about the rating agency’s decision and called the downgrade “arbitrary”. And JPMorgan CEO Jamie Dimon told “CNBC” that he had no understanding for the Fitch rating and described it as “ridiculous”.
Mark Spitznagel: “Largest credit bubble in human history”
The US hedge fund manager Mark Spitznagel, who founded the asset manager Universa Investments in 2007, sees the rating agency’s decision as justified. “We are in the biggest credit bubble in human history. And that’s not my opinion, those are just numbers,” the market expert told the business magazine “Fortune” a few days after Fitch’s decision. “There is no question that we live in an age of leverage, an age of credit, and that will have its consequences.” Data from the New York Fed shows that total US household debt in the US was at a record high of $17 trillion in the first quarter of 2023 and the national debt-to-Gross Domestic Product ratio was 118 percent. Spitznagel believes that the costs of high interest rates mean that household spending will fall, the economy will grow more slowly and central banks will have to adjust interest rates downwards.
Fed is complicit in debt
Although the high level of debt is a more complex problem, the Fed itself is not entirely to blame. The US Federal Reserve has behaved incorrectly since the global financial crisis of 2007-2008, as Spitznagel pointed out to the magazine. One of the mistakes made by monetary watchdogs was the decision to lower interest rates to almost zero and keep them there for years. He also criticized the purchase of government bonds and mortgage-backed securities. According to the expert, the monetary policy comparable to firefighters mismanaging a fire-prone forested area in recent years. If you don’t allow smaller fires to destroy excess vegetation, huge fires can develop that can no longer be controlled. So instead of letting the economy plunge into recession, which would have been tantamount to a small fire, according to Spitznagel, a “powder keg” was created by raising the level of debt, which is just waiting for the first spark. “We have never seen such a high level of total debt and debt in the system,” Spitznagel confirmed in an interview. “But we know that credit bubbles have to burst. We don’t know when, but we know that they have to burst.”
Stock valuations should be significantly lower
So if the powder keg pointed out by Spitznagel actually explodes, it could hit investors in the stock market badly. The S&P 500, the index of the 500 largest listed companies in the USA, has already risen by 14.71 percent this year in an environment of high interest rates and declining inflation rates (as of August 16, 2023), which raises doubts about the valuation of shares let The Buffett indicator, named after stock market legend Warren Buffett, which compares the total market value of all stocks traded in the USA to the US economic output, has been sounding the alarm for months. According to Spitznagel, the data shows that if the stock prices were correctly valued, they “would be much lower now”. Instead, premature optimism about declining inflation rates and the still positive economic development are motivating investors and thus driving stock market valuations higher, according to the investor. “They only look at the here and now,” commented Spitznagel. “It has nothing to do with long-term fundamentals.” A bursting of the credit bubble could therefore mean severe losses for investors.
Moving away from risk mitigation
But how should investors position themselves now? Freely based on the statement of the British economist John Maynard Keynes “The markets can remain irrational longer than one can remain solvent.” According to Spitznagel, investors are often carried away by trends. It may therefore sound surprising that the market expert advises, of all things, to leave risk reduction out of the investment strategy. “My advice to a retail investor would be to understand that risk reduction can be the most costly thing they do. It probably won’t be the crazy investment they just made that will hurt them. It will probably be the things that they do when they think something bad is going to happen. It’s the knee-jerk reaction,” the hedge fund manager said. However, private investors are limited in their options for cost-effective risk reduction.
“Diworsification” warning
The stock exchange expert criticized that in the modern financial world there is always talk of maximizing the risk-adjusted return, but that this description is incorrect. “It’s sort of a cover or a smokescreen: ‘risk-adjusted returns’ are designed to distract from what really matters, and that, of course, is maximizing wealth over time. That’s the only thing that ultimately matters,” Spitznagel explained. Diversification is often mentioned as a way to counter risk, but the hedge fund manager calls this approach “diworsification” as an allusion to the English term “worse” for “worse”. If, as an investor, you pay attention to a diversified portfolio, you can expect a falling total return in the long term. For small investors, risk reduction does not therefore mean securing the portfolio against crashes, but protecting oneself from “stupid things” that one commits out of fear.
Build up cash reserves
Instead of betting on options or equipping the portfolio with supposedly safe investments such as gold, concerned private investors should withdraw from the stock market, Spitznagel told the magazine. Here it could be worthwhile to put the money withdrawn from the stock exchange into your own cash reserves in order to better survive a possible downturn in the market and then be able to get back on board stronger.
Buffett tip on S&P 500 funds
Alternatively, the expert recommends getting into an S&P 500 index fund, as Berkshire Hathayway boss Buffett has advised in the past. “Just buy an inexpensive, broad-based index and make sure you don’t put yourself in a position where you have to sell it if the market falls 20 percent,” Spitznagel suggested. “That sounds like the advice Buffett is giving, and if he’s the greatest investor who has ever lived and probably will ever live — and he is — then that’s probably pretty good advice.” If there is a weak phase, small investors can also increase their position in the fund without hesitation, according to the hedge fund manager.
Buffett is cold on Fitch downgrade
Buffett, whom Spitznagel called a “hero as an investor” in an interview, seems to be relaxed about the Fitch downgrade. In an interview with CNBC, the stock market legend explained that there is certainly room for improvement on the part of the US government as far as the country’s financial policy is concerned, but that the level of the US dollar still speaks for itself. “The US dollar is the reserve currency in the world and everyone knows it,” the Oracle of Omaha assured the TV station. Accordingly, he will continue to buy US government bonds in the billions to secure Berkshire Hathaway’s portfolio.
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