US Debt Limit Cognitive Dissonance
Interest-Rates / US Debt Apr 28, 2011 - 04:26 AM GMTBy: Brian_Bloom
Cognitive dissonance is an uncomfortable feeling caused by holding conflicting ideas simultaneously. The theory of cognitive dissonance proposes that people have a motivational drive to reduce dissonance. They do this by changing their attitudes, beliefs, and actions.[2] Dissonance is also reduced by justifying, blaming, and denying. It is one of the most influential and extensively studied theories in social psychology. (Source: http://en.wikipedia.org/wiki/Cognitive_dissonance )
The following facts provides clear evidence of the emergence of cognitive dissonance in the markets. The question arises: Who is going to change their attitudes, beliefs and actions? Will it be the bulls, who are currently rationalizing that corporate earnings are going to continue growing strongly (as evidenced by the recent strong break up in the market)? Or will it be the bears, who are focusing on rising public debt levels and are currently rationalizing that debt levels matter?
Quote:
"Annual income twenty pounds, annual expenditure nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery." (Mr. Micawber, Charles Dickens)
So, have the principles changed since the days of Charles Dickens? The market seems to think so.
US Banks Warn Obama on Soaring Debt
http://www.cnbc.com/id/42775820
Today’s strong break up in the markets is a clear sign that the majority of investors believe the debt limit will be lifted by at least a trillion dollars and that corporate earnings are going to continue rising.
Here are some simple and easy to understand facts based on the current Public Debt level of $14.3 trillion:
1/14.3 = 6.99% (The percentage by which the market thinks the Public Debt ceiling will be raised)
Movement of public debt in preceding 10 years:
April 25th 2001: $5.68 trillion
April 25th 2011: $14.3 trillion
Compound rate of growth: 9.67% p.a.
Movement of Dow Jones (round numbers):
2001: 9,000 (low)
2011: 12,000 (April)
Compound Growth rate: 2.9% p.a.
Interim conclusions
1. If compound growth in borrowing of 9.67% p.a. has yielded equity price growth of 2.9% p.a. then raising the debt ceiling by 6.99% (by itself) is not going to push equities to new highs
2. Clearly, the market believes one of two things:
a. The debt ceiling will be raised by far more than 6.99% during 2011/12; or
b. Underlying earnings are going to rise strongly because corporate earnings are going to rise strongly
Now let’s look at the movement of public debt since 2008 (when the Global Financial Crisis emerged):
April 25th 2008: $9.3 trillion
April 24th 2009: $11.1 trillion (+19.3% - as a consequence of GFC in September)
April 26th 2010: $12.9 trillion (+16.2%)
April 25th 2011: $14.3 trillion (+10.9%)
Compound Growth rate: 15.4% p.a.
Dow in October 2008: 8000
Dow in 2011 (April): 12,000
Compound growth rate: 14.5% p.a.
Alternatively:
Dow at low (in 2009): 7,000
2011 (April): 12,000
Compound growth rate: 30.9% p.a.
Interim Conclusion
Investors are focusing on the lower number of 7,000 as opposed to the earlier date at which stimulation began to kick in. (The markets began to collapse in September 2008)
Conclusions
1. The facts are clear that government borrowings have risen at a faster pace than equity prices
2. Therefore, for equity prices to continue rising, either:
a. US Public Debt will have to explode at a rate that is far greater than the historical 9.67% p.a., or
b. Underlying corporate earnings are going to have to continue rising because of a strong economy
Question: What is going to “drive” the growth in underlying earnings, given that world energy output per capita is not growing?
Overall Conclusion
The market appears to believe that public debt is going to continue to explode as the Fed continues to stimulate with further Quantitative Easings
Quote from the above article:
“The world is watching, and while America must pay its bills, if we ask for more credit, we must prove worthy of it,” a spokeswoman for Eric Cantor, the House majority leader, told the Financial Times.
“That’s why President Obama, vice-president Biden and the leaders of their party are obligated to ensure that any debt limit increase is accompanied by serious reforms that immediately reduce federal spending and reverse the culture of debt hovering over Washington.”
Analyst Observation
The probability of a train smash is rising
By Brian Bloom
Once in a while a book comes along that ‘nails’ the issues of our times. Brian Bloom has demonstrated an uncanny ability to predict world events, sometimes even before they are on the media radar. First he predicted the world financial crisis and its timing, then the increasing controversies regarding the causes of climate change. Next will be a dawning understanding that humanity must embrace radically new thought paradigms with regard to energy, or face extinction.
Via the medium of its lighthearted and entertaining storyline, Beyond Neanderthal highlights the common links between Christianity, Judaism, Islam, Hinduism and Taoism and draws attention to an alternative energy source known to the Ancients. How was this common knowledge lost? Have ego and testosterone befuddled our thought processes? The Muslim population is now approaching 1.6 billion across the planet. The clash of civilizations between Judeo-Christians and Muslims is heightening. Is there a peaceful way to diffuse this situation or will ego and testosterone get in the way of that too? Beyond Neanderthal makes the case for a possible way forward on both the energy and the clash of civilizations fronts.
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Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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