Kass: Why I Disagree With Jim Paulsen
Below are my core objections to/concerns about Jim's view that higher interest rates will produce rising stock market valuations.
The U.S. currently carries a record debt load. The U.S. is burdened with more debt than at any time in history. Our debt load now totals a record $17 trillion -- it topped $1 trillion in 1982, stood at only $5 trillion in 2000, was less than $8 trillion in 2005, and 2012 represented the first year since 1946 when the debt eclipsed GDP. The average maturity of the U.S. debt is a bit over five years. So, every 100-basis-point increase will result in an additional $170 billion of interest expense for the U.S. government. Rising interest rates, therefore, will result in a massive headwind to domestic growth - a potentially value destructive event for the market's valuations.
Higher interest rates will jeopardize the U.S. housing recovery. It is generally agreed upon that in addition to buoying the U.S. stock market, quantitative easing is aimed to insure a steady and durable recovery in the residential real estate market, both with regard to new purchases and refinancing -- the latter is an important component to personal spending. While the U.S. housing market has recovered from the depression of 2007-2010, that recovery remains fragile. Home prices are up 8% year over year but still well below the prior peak of 2006. Any meaningful increase in interest rates will jeopardize housing and, in turn, slow any improvement in the domestic economy, another potentially value-destructive event.
Higher interest rates will hurt other rate-sensitive areas of the economy. Installment lending, automobile lending and the like will feel the sting of higher interest rates. I worry that U.S. consumers and businesses have grown addicted to low interest rates and that any change of this status will cause an economic shock.Small businesses (and lesser corporate credits) will suffer disproportionately from rising interest rates. Small businesses, which have not had ready access to the capital markets to the degree that our largest companies have had, will be hurt by the rising financing costs associated with rising interest rates. In all likelihood, their already depressed confidence levels will get even more depressed. This could be another blow to growth and to market valuations. New structural headwinds exist today that never existed in previous times in history. While it may be argued that global easing has reduced the chance of economic tail risks, some serious issues remain (e.g., deleveraging, structural disequilibrium in the labor market, etc.) that are growth-deflating. So I would question Jim's examples of P/E multiples in previous rising interest rate backdrops, as those structural headwinds and challenges did not exist in the past.
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