KBRA Financial Intelligence

3 Things in Credit: Peak Trump, Animal Spirits, and Debt Warning

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

Something that caught our eye this week was the realization that the market value of Walgreens Boots Alliance—the drugstore chain that we here in the States know simply as Walgreens, and those in the UK know as Boots—has fallen from nearly $100 billion in 2015 to $8 billion today. How does an advantageously scaled retailer of consumer essentials with strong brand equity suffer such a fate? The lookback shows flawed strategic thinking, poor execution, span of control deficiencies, and an inappropriate capital structure. There are a lot of cautionary lessons in this case study.

This week, our 3 Things are:

1. Peak Trump. Are we there yet?

2. Animal spirits. The NFIB survey suggests it’s real.

3. Debt warning. The BIS issues a sobering missive.

Alright, let’s dig a bit deeper.

Peak Trump.

The euphoric risk markets’ reaction to Donald Trump, and what his supporters call a “mandate,” was predictable, I suppose. This, despite no shortage of credible voices that suggested otherwise ahead of the election. We attribute market reaction to (1) the supposed unleashing of animal spirits on the part of business owners/managers/consumers/investors that comes from having a businessman back in the White House; (2) Trump’s growth-positive policy proposals, including promises to deregulate and cut taxes; and (3) merger premia coming back into company valuations after the Biden administration had wrung most of that out.

Is this “sugar high” due to fade? Reasons why it should are both fundamental and technical. On the fundamental side, tariffs and labor force limitations, yet to be defined, figure to be growth limiting and/or inflationary. And on the technical side, there are valuation and relative-value considerations. Valuations are super rich by historical standards. Investment-grade spreads are at 27-year tights. High yield? At 17-year tights. Large cap stocks are trading at forward P/Es seen just twice in 30 years excluding COVID’s distortions.

And yet, the median forecast by Street strategists for the S&P 500 calls for the index to jump another 8% in 2025, and the view is eerily consistent across participants. Of the 19 strats surveyed by Bloomberg, only one is calling for the index to fall in 2025 from current levels, and that’s by all of 1%.

Money, of course, keeps flowing into U.S. stocks relative to rest of world, where growth is slow or slowing, and where the siren’s call of technology in general and AI in particular is faint. We talked about this last week, noting that U.S. stocks account for 70% of global stock market value despite representing just 27% of economic output.

So, Peak Trump? We think about it this way: Right now, it’s easier to feel the tailwind (animal spirits) than the headwind (tariffs), because the latter has yet to be defined. Is it a negotiating tactic that will be used judiciously, guided by the pragmatic Treasury Secretary? Or will it be deployed broadly and materially under some ideological or retributional banner? And then there is the valuation issue, where the upside/downside has to be skewed toward the downside given the high valuations from a historical perspective. So, notwithstanding the Trump and Santa Claus rallies currently underway, we’re skeptical as to how much better we can trade.

Alright, on to our second Thing—Animal spirits.

Keynes taught us that animal spirits cause investment prices to move on emotion rather than intrinsic value. And nowhere is that more evident than among small business owners, at least according to the NFIB, the self-proclaimed “Voice of Small Business.” Their Optimism Index in November, taken after the election, in a word, ripped. It jumped eight points to 101.7, above its 50-year average of 98 for the first time since June 2021. Of the index’s 10 components, nine moved higher and one was unchanged. For instance, the net percent of owners expecting the economy to improve rose a remarkable 41 points from October to a net positive 36%. Those expecting higher real sales volumes rose from a negative 4% last month to a positive 14%, its highest level since February 2020.

Moreover, the NFIB’s Uncertainty Index fell from its worrisome record high of 110 last month to 98, still well above its 50-year average of 67, but a significant move in a positive direction, nonetheless.

The NFIB did not mince words interpreting the data. “The election results signal a major shift in economic policy,” it opined, “particularly for tax and regulation policies, that favor economic growth.” They added, “Economic and employment growth have been dominated by government spending, financed with massive deficits, crowding out private spending with higher prices and interest rates.” The NFIB expects Trump’s election, and policies, will bring down costs over time to the private sector, unleashing animal spirits in the process.

That is likely to drive growth higher during Trump’s honeymoon period—call it the first six months—before the policy fog starts to lift and we get a better look at what’s possible. But in the meantime, watch for the emotion Keynes talked about to run free.

Alright, on to our third Thing—Debt warning.

The Bank for International Settlements, or BIS, came out with its Quarterly Review this week and warned of the threat of soaring government debt to financial stability. The BIS has been around since 1930 to support monetary and financial stability through international cooperation. It provides services to, and is owned by, 63 central banks from its headquarters in Switzerland.

The BIS observed that the global fiscal outlook remains “acutely worrying,” adding that “government debt trajectories represent the most serious threat to macroeconomic and financial stability.”

In its review, the BIS noted that U.S. Treasury yields are at levels reached in 2007-08 when the GFC was raging. We would add that the ICE BofA MOVE Index, which tracks U.S. bond market volatility also spiked, before simmering down to still elevated levels post the election.

Needless to say, the long-standing debate over how much debt the U.S. can carry has moved back to the front burner. Voices such as BlackRock CEO Larry Fink and the Peter Peterson Foundation regularly warn that “snowballing” federal debt (Mr. Fink’s characterization) is crowding out private capital.

We would make the following observation. As the issuer of the world’s undisputed reserve currency, the U.S. will attract buyers for its debt as long as those buyers have confidence in U.S. stability, stability that comes from the integrity of its rule of law, the strength of its institutions, the size of its economy, and the strength of its military. It also comes from confidence that it can manage its fiscal house appropriately. Is that being tested given the recent runup in debt burden, which resulted from issuing massive amounts of debt to cushion the blow from our two most recent crises—the GFC and COVID—and the recent rise in rates? Yes, but it is worth noting that the current level of rates is well inside levels seen typically before a zero interest rate policy became the Fed’s modus operandi post the GFC. And anecdotally, we routinely see net buyers of U.S. Treasuries in times of global stress.

Do we believe there is no cost to running up debt, especially at these higher-for-longer interest rates? No, that just seems to be counterintuitive and maybe a bit naive. And, from a practical matter, we certainly wouldn’t rule out the prospect that bond vigilantes—animal spirits of a different stripe—might have a different view. Which is why fixed income investors around the world will be watching closely the extent to which the Trump administration follows through on some of its more inflationary policy leanings.

But for now, the warnings given by the BIS this week we believe apply more to smaller jurisdictions, which could still have their own “Liz Truss moments.”

So, there you have it, 3 Things in Credit:

1. Peak Trump. We’re not there yet, but we’re close.

2. Animal spirits. The NFIB survey suggests it’s real.

3. Debt warning. The BIS is probably early, but not off base.

As always, thanks for joining. That’s a wrap, at least for 2024. We’ll be back in the new year with more 3 Things. Enjoy the holidays.