Chad Padowitz, co-chief investment officer at fund manager Talaria Capital, said the answer is nuanced.
“I wouldn’t regard this discussion about the end of US exceptionalism … I just don’t think this is about that specifically,” Padowitz told InvestorDaily.
“The US has benefited – and other countries as well – but certainly the US has been a significant beneficiary of interest rates, as in the cost of capital, basically being at the lower end of where one would think it would be when one looks at cash flow growth and earnings growth and economic activity.”
The advantage, he explained, came from the low cost of capital without the usual trade-offs of weak economic activity. But that balance has shifted.
“You’ve had significant valuation expansion because if companies are growing quite well and interest rates are let’s say 2 or 3 per cent, then money in 10 years time is still worth quite a lot of money in today’s money … But if you start throwing in 5, 6 per cent, larger numbers, suddenly it’s no longer worth as much and that tends to make valuations come down,” Padowitz said.
“That’s really where we’re getting at, this level of consistent expenditure exceeding tax receipts, substantial amounts of debt, and a significant current account deficit as well, which means they have to keep finding money from elsewhere.”
The US’s growing fiscal deficit and borrowing needs essentially slowly eroded its appeal, as the country’s borrowing needs ballooned. At the same time, interest rates rose significantly higher compared to post-GFC standards and the COVID pandemic.
“It’s not like you’re short a trillion dollars and you can take it from your own population, because of the current account deficit you have to find the money outside of America … So, you have to start effectively bribing them [external capital providers] with higher rates of return,” he explained.
Padowitz pointed to the 10-year government bond yield which has, broadly speaking, stayed “pretty high”.
This dynamic of consistent deficits and borrowing, he said, is already pushing the interest payments on existing debt above the level of US military expenditure – a sobering benchmark.
“It’s already approximately 4 per cent of GDP interest cost… It’s [interest costs] already costing more than military expenditure, so these are really big numbers that aren’t going away anytime soon,” he said.
According to Padowitz, without substantial policy changes from the US government, the world’s largest economy faces a future of either dramatically higher interest costs, forced fiscal consolidation, or potential financial instability as financial markets and investors question the rising US government debt.
Asked about market prospects, Padowitz said: “The combination of increased debt issuance and potentially reduced foreign demand creates significant market risks”.
He suggested investors should prepare for “very low returns to potentially no returns” in the years ahead, driven by high starting valuations and diminishing tailwinds from cheap capital.
“The variables are much more challenging given valuations, given interest rates, given the debt situation … so being prudent is a very good thing to be at the moment,” he said.
In this environment, Talaria’s investment focus is clear.
“We are finding opportunities in companies that are less economically sensitive… lower duration, meaning lower valuations, and also better balance sheets,” Padowitz said.
He highlighted sectors like healthcare and pharmaceuticals, which are “out of favour” due to government policy, but possess strong fundamentals, as well as utilities, certain fertiliser companies, and low-cost oil producers.
Conversely, the firm is steering clear of the “high growth, high valuation” sectors including the IT sector, while maintaining a “negligible exposure” to “growth” areas of the market, such as banks.
“We’re a value fund so we don’t forecast high levels of growth into the future … We don’t own any of the Mag Seven companies. It’s not a structural thing, it doesn’t mean we cannot own them … It’s not really our process to try and forecast multiple years into the future about technology change, that tends to be a very difficult and costly exercise,” Padowitz said.
He cautioned about the risks of disruption, recalling lessons from the mobile phone and dotcom eras.
“You bought Motorola and Nokia back in the day thinking it would be good, it didn’t work out well. And obviously the internet’s been a phenomenal success story but the vast majority of dotcom companies you bought in 2000 kind of lost everything,” he said.
Finally, Padowitz sees more attractive opportunities outside the US market.
“We see a lot more opportunities, frankly, elsewhere,” he said.
Apostle Funds Management’s investments director, Harrison Lane, similarly highlighted the need to prioritise assets with strong cash flows, resilient balance sheets, and low debt exposure in the wake of OBBB’s passage.
“Further, shifting towards inflation-protected securities can provide a hedge against rising borrowing costs and market volatility,” Lane said.
Moreover, he pointed to alternative investments – including alternative credit and opportunistic style hedge funds – as a source of “particularly compelling” diversification.
“We continue to believe that accessing this area, particularly in sectors that are less sensitive to interest rate fluctuations such as healthcare, utilities, and consumer staples, can offer strong risk-adjusted returns while weathering these macroeconomic headwinds.”
Earlier this week, VanEck warned that the OBBB will push the debt beyond its current 124 per cent of GDP – potentially to 160 to 200 per cent – primarily by renewing and making permanent expiring tax cuts, and the deficit north of 5 per cent of GDP.
