Unboxing Your Boxing Day Mailbag

Happy Boxing Day! Traditionally, this is the day the “downstairs” portion of the house would spend with their families to celebrate the season after serving “upstairs” on Christmas. And being your humble servants, what better day for us to open your Qs and, hopefully, give you some As?

Who are the largest holders of US government debt?

US investors and the Fed. Current gross public debt is about $36.2 trillion.^[i] Of this, the US government owns about $7.3 trillion, via the Social Security trusts and other government vehicles.^[ii] This is money Uncle Sam owes himself, which effectively cancels, leaving net public debt at $28.9 trillion.^[iii] As of September, the latest data available, foreign investors (governments and private investors) owned $8.7 trillion (with $3.9 trillion owned by governments and the rest of the “official sector” and the rest by investors).^[iv] This leaves just over $20 trillion with Americans and the Fed.^[v]

Among foreign holders, the largest is Japan at about $1.1 trillion.^[vi] China is number two at $770 billion, followed closely by the UK.^[vii] So for all the headline talk about China owning our debt, it is actually a bit player in the grand scheme of things. And for all the fear of it selling spiking US debt costs? A decade ago, direct holdings were nearly $1.3 trillion.^[viii] It steadily sold over that span, cutting holdings by roughly $500 billion. Did you notice?

How should I allocate my portfolio during a bear market?

There isn’t a one-size-fits-all solution, alas. All bear markets are different, and it also depends on the outlook for fixed income markets at the time. If you see a high likelihood there is a deep, long downturn ahead of you, reducing equity exposure probably makes sense. But whether you would want to emphasize cash, bonds or other securities would generally depend on interest rates’ likely trajectory and inflation (which erodes cash returns). If you identify a bear market is underway late—or expect a short and shallow one—it may make the most sense to grit your teeth and keep a high equity allocation in order to maximize your likelihood of capturing the rebound. There is another, more granular consideration, too: Whether liquidating positions with large unrealized gains is a net benefit. Lastly, remembering you could always be wrong, it may make sense to keep a not-small amount of your portfolio in more defensive stock categories and blue chips, perhaps with some short positions as an offset.

But again, it all depends on a bear market’s specifics. There is no such thing as a “right” portfolio position for every bear market. All cash or bonds? What if inflation is hot and yields low? Gold? More volatile than stocks with no yield and no reliable history of rising when stocks fall. The outlook for all asset classes, not just stocks, is important. Which is probably not the answer you wanted, but investing is complicated.

What happens if China has to default on their debt?

It didn’t get much attention, but we kind of already got the answer last year, when local government finance vehicles—a big chunk of China’s government debt—hit tough times. This is where China’s predominantly state-controlled financial system came in handy: The government restructured the debt and ordered banks to roll over their existing holdings into the new securities. Everyone played their part and moved on. Chinese markets struggled, but global markets had a great year.

As for central government debt, who knows—to get to that point, given China’s relatively small amount of external debt and massive stockpile of foreign currency reserves, there would probably have to be some massive economic crisis. That would probably be the main concern, with a default the after effect. And it wouldn’t be good, but we are very, very far in the realm of speculation here, discussing a matter with electron-microscopic probability of occurring.

In short, we see this as an academic question, not a near-term market driver you can assign probabilities to. Markets move on probabilities, not distant possibilities. You can set this one aside, in our view.

What do you think about dollar cost averaging?

This refers to the practice of buying stocks a little bit at a time, putting more money in as and when prices fall. Practitioners claim it is a way to hedge against short-term volatility. What this is not: The repeat retirement contributions made through your paycheck. Those you have little control over, given the law mandates 401(k) contributions come through pay deferral. We are talking about when someone has a sum of cash and chooses to dole it in piecemeal.

We don’t think it is beneficial. Reason being, short-term volatility is unpredictable. If you wait for a better price, you may wait indefinitely and miss big returns along the way, limiting your compound growth potential and making it more difficult to reach your long-term goals.

In our view, if you are bullish and your goals require equity exposure, it makes most sense to be fully invested rather than waiting for a rainy day or dripping it in for fear of simple volatility that may not strike or do so in any meaningful way. If that much short-term volatility is outside your comfort zone, then the answer is probably having a blend of stocks and fixed income, not averaging into an allocation that you could fundamentally lack comfort with.

What about dogecoin—what is the difference between it and other cryptocurrencies?

The industry would say that dogecoin is a “memecoin,” nothing more than a joke, while other cryptocurrencies purport to have actual use and are somehow better.

We … we kinda think they are all the same? Digital commodities based on ideas, tokens whose prices swing on sentiment, not real-world supply and demand? If anything, the memecoins are a little more honest about this than the supposedly real cryptocurrencies, acknowledging there is no fundamental underpinning beyond hype.

But then again, maybe we are just old fuddy-duddies who don’t get it.