Government intervention and mounting debt are reshaping the global economy, forcing investors to adapt to a new era where prudence, liquidity and resilience matter more than ever.
The global economy is increasingly shaped by heavy government spending, growing debt piles and a rising sense of uncertainty. Adding further worry is the natural push-and-pull of the market is being steadily replaced by government control, particularly in the US which is actively managing the economy with political considerations taking priority over economic ones
While the US has always blended private enterprise with state influence, the mix has become far more one-sided in recent years. As the invisible hand of the market is swiped aside by the clunking fist of government, investors must come to terms with a new reality – where and how capital is allocated is no longer driven only by profits and prices.
We are witnessing a major turning point. The era of deep global integration that began in the 1990s is giving way to what might be called a “great separation” – a fight for capital. The old system brought great benefits, but it also created serious imbalances. Too much debt in the real economy, oversized US deficits dependent on foreign funding, and a lopsided global manufacturing landscape.
Nervousness about this new reality is clear, with government bonds in the US, Europe, and Japan being sold off. Unless you are a pension fund matching long-term liabilities, buying long-term government debt today is an act of optimism. A government bond is only worth the future income it promises, backed by future taxes.
When governments run huge, ongoing deficits, as the US does, they are spending more than they earn. That means investors who buy their long-term bonds are betting that the government will eventually put its house in order.
In today’s climate, that’s a risky wager. Whether that bet pays off remains to be seen, but it’s clearly not without risk.
There’s only so far government debt can grow. Early on, borrowing can boost the economy, but over time, the benefits shrink while the risks grow. Sooner or later, the debt burden becomes too heavy, flexibility disappears, and solvency becomes a real question – even for the US. Eventually, every economy must face a reckoning, whether through growth, inflation, austerity, or restructuring.
Proponents of Modern Monetary Theory disagree. They say the only real risk is inflation – that as long as prices stay stable, governments can keep borrowing and printing money indefinitely. But history shows that even countries that control their own currency aren’t immune to rising debt costs, falling market confidence, or a reduced capacity to handle crises.
There are five warning signs that an economy is nearing the end of its debt cycle:
High absolute debt levels, persistent and rising deficits, rising debt service costs, diminishing discretionary spend and shortening maturities. By these measures, many developed economies are late in the cycle.
In this new environment, investors should consider an approach based on liquidity, prudence, and resilience
Specifically and first, companies with strong balance sheets. Firms carrying heavy debt will struggle as refinancing gets costlier. Companies with low debt and healthy cash flow, on the other hand, have the freedom to act and not just react. This is when the strong can gain ground while the weak are under pressure.
Second, focus on short-duration assets. Businesses that generate cash quickly and earn back their investments fast are better equipped to handle rising borrowing costs. With the era of zero interest rates over, the risk of holding long-term assets is back. In short, think short-term and cash strong.
Third, own real assets and inflation protection. With inflation unlikely to disappear soon, tangible assets and those linked to rising prices offer some of the best ways to preserve wealth. Infrastructure, commodities, and inflation-protected bonds can help shield your capital.
Finally, diversify into less correlated sources of return. This includes strategies that profit from market volatility or periods of stress. One example is the “volatility risk premium”- the steady returns available from selling insurance to other investors seeking safety. This kind of alternative return is central to Talaria’s approach.
Despite our cautious tone, there are still opportunities out there. Defensive sectors like consumer staples and healthcare continue to offer up good possibilities, even in today’s bullish stock market. The same is true for companies with genuine financial strength and the ability to raise prices, which still trade at attractive discounts.
So, while periods of regime transition are always challenging, they can reward investors who favour prudence, patience and strong underlying cash flows. We still believe that this is a market for sober optimism.
Hugh Selby-Smith, co-CIO at Talaria Capital
