As a number of states are struggling with deficits bond buyers are happily looking at after tax yields of close to 7% from states like California at the same time that 10 year US Treasury notes are going for less than 4%. It is usually the other way around. However, looking at debt and growth it could be that opening the tap for more credit could, in fact, choke off the recovery. Sometimes how to make sense of stock market news starts with knowing which news to watch. Watch to see what debt does to the recovery.
Looking at debt and growth there are a number of things to consider. As production reports are up there seems to be hope for an American economic recovery. Consumer spending has crept up a bit. Does that mean that consumers were hoarding cash or that they trust the future again and using their credit cards? The news has been full of the possibility of European debt defaults but the more interesting debt news may be closer to home. How to invest in the stock market during hard economic times may have taken a turn toward bonds. “After tax” yields on tax free bonds from California and Illinois are out performing Treasuries for now. Then again, as the debt issue broadens and the US and other countries with good credit ratings kick in to help the others there is always the risk of a loss of credit worthiness as we see with the possibility of Japan’s rating going down. That could lead buyers to requiring a higher rate on treasuries to buy US debt.
For longer term investment the concern about the previously unheard of debt the US is planning to pile on in the next years is that it may drive interest rates substantially higher, making it harder for companies to get credit, expand, add employees, and pay dividends. Looking at debt and growth may be telling us that Stock investing in the coming years may have to do with picking companies with little debt as a first concern and cash reserves as the second. Traditionally a company that has excess cash is criticized for not rewarding shareholders and becomes the target of a takeover. If interest rates go too high the best survivors will possibly be those with what today would be considered excessive asset to debt ratios.
Picking new winners in the new world of high debt and interest rates will mean, as always, looking for well managed companies that make efficient use of their assets, and companies with low debt and promising products. High cost of entry businesses are typically safe from competition in such times, providing that they hold on to cash. A lot of the very high tech world takes a fair amount of cash to get started. Perhaps the world of startups will suffer a little in the process of dealing with debt. On the other hand too much cash chasing poor investment opportunities has helped contribute to events like the dot com bubble so maybe a little austerity will not be such a bad thing. While thinking about debt and growth, or lack of it, take a look at those bonds and do a little calculation on what your after tax yield would be.