Herbert Stein was an American economist and chairman of the Council of Economic Advisers under Presidents Richard Nixon and Gerald Ford. He coined “Stein’s Law,” which states: “If something cannot go on forever, it will stop.” Nobody told Congress, which controls the nation’s purse strings. The U.S. debt continues to rise by ever larger amounts. The chart below illustrates that the aggregate of U.S. debt is ~ 1.3x the size of the U.S. economy. The debt is larger relative to the economy now than it was at the end of World War II. The debt percentage would fall at that time as the peacetime economy grew quickly and government spending, no longer prosecuting a war, fell sharply. However, Congress doesn’t have the tailwind of plummeting wartime spending to help it get its fiscal house in order. That can only be achieved with meaningful spending cuts and tax increases. Instead, increasing state and local tax deductions is a high priority. While the budget resolution’s proposed cuts of $2 trillion over the next 10 years might seem like a lot, it isn’t. $200 billion in spending cuts is just 10% of the annual $2 trillion deficit. While Congress appears to be paying little attention to the growing debt and deficits, the bond markets aren’t so sanguine. The 10-year Treasury note yield has spiked to around 4.6%. Its 30-year bond counterpart has jumped to over 5.1%. Why is this important? Because that is the highest post- great financial crisis 30-year yield. You’ll observe that before the crisis, 30-year rates were higher, and in some cases, much higher than they are today. Rising U.S. Treasury bond yields can impact stocks in several ways. As yields rise, borrowing becomes more expensive for individuals and for companies. Items typically purchased with credit become more expensive, which can delay (or even prevent) these purchases. Higher capital costs can reduce corporate profits, particularly for companies relying on debt to fund expansion. We occasionally refer to “high-duration equities,” which refer to growth stocks that often carry high valuations based on future earnings and will likely face downward pressure. Rising yields increase the discount rate used in valuation models, reducing the present value of all future cash flows, which in turn could lead to lower stock valuations generally. The United States does not face this problem alone. The Japanese long bond yield has been rising sharply, too, and is now at levels unseen since 1999. At the time, Japanese government debt was roughly 135% of GDP. Now it is rapidly closing in on 250%. This happens as the S & P multiple (the trailing 12-month P/E ratio) is above average. The trade If you are concerned that long-term bonds could fall further, one might consider a bearish calendar spread on the iShares 20+ Year Treasury Bond ETF (TLT) . The trade consists of buying a longer-dated put, partially financed by the sale of nearer-dated calls and puts: Buy 1 Sept. 30 $84 put Sell 1 June 30 $80 put Sell 1 June 30 $ $90 call DISCLOSURES: None. All opinions expressed by the CNBC Pro contributors are solely their opinions and do not reflect the opinions of CNBC, NBC UNIVERSAL, their parent company or affiliates, and may have been previously disseminated by them on television, radio, internet or another medium. THE ABOVE CONTENT IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY . THIS CONTENT IS PROVIDED FOR INFORMATIONAL PURPOSES ONLY AND DOES NOT CONSITUTE FINANCIAL, INVESTMENT, TAX OR LEGAL ADVICE OR A RECOMMENDATION TO BUY ANY SECURITY OR OTHER FINANCIAL ASSET. THE CONTENT IS GENERAL IN NATURE AND DOES NOT REFLECT ANY INDIVIDUAL’S UNIQUE PERSONAL CIRCUMSTANCES. THE ABOVE CONTENT MIGHT NOT BE SUITABLE FOR YOUR PARTICULAR CIRCUMSTANCES. BEFORE MAKING ANY FINANCIAL DECISIONS, YOU SHOULD STRONGLY CONSIDER SEEKING ADVICE FROM YOUR OWN FINANCIAL OR INVESTMENT ADVISOR. Click here for the full disclaimer.
