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Conclusion: The math is pretty simple – debt at extreme levels equals slow growth which negatively impacts equity and natural gas returns.

While we are encouraged to see a savvy firm like Goldman Sachs take their GDP estimates down closer to our street low estimates for 2011 GDP growth of 1.7%, it is likely that our estimate continues to have negative bias.  The key current factor driving our view of slowing growth is debt on the balance sheet of the United States.

The future downward risk to our GDP growth estimate will likely hinge on two key factors: housing prices and inventory.  If housing prices unravel quicker than we expect, it will have a direct impact on consumer spending, which is ~70% of GDP.  Additionally, if inventory building were to slow, which was a major contributor to last quarter’s GDP growth number, it would create a major economic growth headwind on a reported basis.

Currently, our estimate for debt-as-a-percentage of GDP for 2010E is 93.2% and 96.1% for 2011E.  The wild card variable for this number is that it assumes no further stimulus (though with yesterday’s “quantitative easing light” this ratio will grow), which would obviously step up the ratio dramatically in the short term.  Leaving future stimulus out of our projections is appropriate given the momentum that Republicans have in polls, and the potential austerity measures that are associated with such.

In our 40+ page sovereign debt presentation from early August (email us at if you want a copy), we highlighted a piece of long term analysis from Professors Reinhart and Rogoff from their recent paper titled, “Growth in a Time of Debt.”  In the paper they look at 220 years of data comparing debt levels of countries to their underlying growth.

The key take away from their paper is that as sovereign debt balances accelerate and eventually reach the 90% debt-to-GDP level, which we have coined the Rubicon of Sovereign Debt, growth slows dramatically.  In fact, the analysis of 2,317 observations has a statistically significant 352 observations at, or above, 90% debt as a percentage of GDP.  Collectively these observations show us that growth averages at 1.7% beyond the Rubicon of Sovereign Debt , which is almost three standard deviations below the collective growth rates at lower debt levels.

The second derivative of this analysis is, of course, equity returns.  In effect, how do equities perform in periods of slower growth?  We looked at the annual returns for the S&P500 for the last 30-years versus the GDP growth in each period.  The conclusion was that in low growth periods, equity returns lag.  The key conclusions of the analysis were as follows: 

  • In the five years with the lowest GDP growth of the past 30-years, the average return of the S&P500 was 2.5%; and 
  • In the five years with the highest GDP growth of the past 30-years, the average return of the S&P500 was 19.8%. 

The question of course is: what else is impacted by slow economic growth? 

We also took a quick look at the returns of natural gas, the commodity which is priced domestically and most directly impacted by U.S. economic growth.  Not surprisingly, the results were very similar.  For this analysis we were only able to look at the past 10-years of data, but in the four years with the highest GDP growth in that period the average year-over-year price gain for natural gas was +16.8%, while in the four years with the lowest GDP growth prices declined an average of (-3.4%) year-over-year.

The math is pretty simple – debt at extreme levels equals slow growth, which negatively impacts equity and natural gas returns.

Daryl G. Jones
Managing Director