Gravitas: Debt Ceiling

May 19, 2023 | Michael Newton


The Newton Group Insights

The self-imposed U.S. debt ceiling, established in 1917, sets a legally defined limit on how much the U.S. government can borrow to pay its bills. This limit has been reached and raised over one hundred times. When could the U.S. default on its debt? Some optimists think it might not come until this summer, but new data shows that the Treasury could run out of money within two weeks. Bloomberg reported that Treasury’s cash balance fell to $87 billion on Monday from about $140 billion Friday, partially due to an unexpectedly large volume of state and local-government securities redemptions. US political strategist Greg Valliere outlines the options and most likely outcome of the US debt ceiling situation. 1) Use of the 14th Amendment to the Constitution to avoid default: A gimmick, but an increasingly plausible option. 2) Reaching a budget deal by early June: Unlikely, not enough time, and there’s little consensus between the two parties on spending cuts. 3) A “discharge petition” to force a Congressional vote: too complicated, not enough votes. 4) An extension until later in the summer: The logical move, giving negotiators a few more weeks and 5) A debt default: Can’t totally rule it out, but these other options will come first. Top U.S. congressional Republican Kevin McCarthy said a deal to raise or suspend the debt ceiling could potentially be reached in time to hold a House vote next week. Bottom line: With President Biden in Asia until Sunday and negotiators making very slow progress, the issue to watch will be Treasury cash balance data — which is not looking good. But keep in mind that the market is well aware of what is going on, and it is very likely that this is all factored into current prices. We believe the likelihood of failing to reach a deal and consequently defaulting on the debt is relatively small BUT I do not consider this a sleeper event and will be watching carefully..

Should you have any questions or concerns, please feel free to reach out.

Portfolio Notes

(+) indicates a positive development, (-) indicates negative, and (~) indicates neutral

(~) Constellation Software (CSU-T) reported mixed Q1 earnings. Starting with the positives, organic growth and revenues both improved Y/Y and came in ahead of street expectations. On the negative side of the ledger, EBITDA came in approximately 5% below consensus estimates, weighed by lower-than-expected margins. With respect to the latter, RBCCM admits that the Alterra acquisition is likely to drag margins lower in the initial quarters but should track in-line with CSU’s high teens hurdle rate. Put differently, RBCCM doesn’t think Alterra should overshadow the strong underlying fundamentals at CSU. While secular growth has outperformed software consolidators year-to-date, we continue to view CSU as the go-to tech name within the Canadian market given its attractive FCF generation and the fact that CSU can work in all parts of the business cycles. Owned in Core Portfolio.

(+) Deere (DE-US) Usually a slowing economy means stalling sales for machine-makers, as customers try to use their existing equipment as long as possible. Yet business has been booming recently for John Deere, an American farm-equipment giant. High crop prices, buoyed by Russia’s invasion of Ukraine, have nudged cash-flush farmers to upgrade their kit just as the company’s pandemic-era supply-chain problems have eased. Q2 GAAP EPS of $9.65 beats by $1.01. Revenue of $17.39B (+30.1% Y/Y) beats by $2.52B. Full-year net income forecast increased to $9.25 billion to $9.50 billion with cash flow from equipment operations expected to be $10.00 billion to $10.50 billion. Deere has also been bringing its products into the digital age. It has added driverless tractors, drones and weed-spotting sprayers to its product line, and has been hiring techies laid off by Silicon Valley firms. In January John Deere’s boss gave the opening address at the Consumer Electronics Show—a clear testament to its changing corporate identity. Owned in US Portfolio.

(-) Danaher (DHR-US) reached a new 52-week low this week. At one point, the stock was down for seven days in a row. This is normally such a steady stock. Last month, Danaher reported Q1 earnings of $2.36 per share. That was an 11-cent beat. For Q2 and the rest of the year, Danaher sees non-GAAP base-business core-revenue growth in the “mid-single digits.” Previously, the guidance was for the high-single digits. Later this year, Danaher will spin off Veralto. That’s the name for its Environmental & Applied Solutions division. Owned in US Portfolio.

(-) Home Depot Inc. (HD-US) posted in-line earnings and a miss on sales. Sales decreased 4.2% Y/Y (comparable sales -4.5%) driven by lumber deflation and extreme weather. Average ticket was flat Y/Y compared to the high-single-digit increases seen in past quarters, while traffic was down -4.8% indicating slowing demand. We continue to like the long-term growth of the business given its investments in omnichannel, IT infrastructure, and supply chain. The business is also positioned to benefit from the profitable professional market. We believe this to be a high quality company and a long-term compounder. We would be buyers at these levels, however patience will be required as the current macroeconomic cycle continues to play out. Owned in Core Portfolio.

(new) SPDR S&P Regional Bank ETF (KRE-US) US regional banks are more oversold right now relative to the S&P 500 than they were in either the depths of the 2008 Financial Crisis or the 2020 Pandemic Crisis. That likely makes them a good long trade. The KRE ETF (S&P Regional Bank Index) has started to lift its head in the last few days, and the group is still down 32 percent on the year. US regional banks could be a good speculative “Buy” here, but their long run stock price performance says to both keep return expectations modest and sell at the first whiff of incremental trouble. We plan to rent this sector for a while, but we certainly don’t want to own them forever. New position in Opportunity Portfolio.

(~) Oneok (OKE-US) Last weekend, the company agreed to merge with Magellan Midstream Partners in a deal that would create the second-biggest midstream operator in the U.S. with a market value of $40 billion. Investors weren’t sold on the deal. One potential reason analysts noted is the lack of clarity around commercial synergies. Broadly, we think the deal is an excellent one for both parties. It adds a wide-moat partnership with an exemplary management team that is throwing off very substantial cash flows. The deal would diversify Oneok’s asset base, which is primarily natural-gas-focused, to include refined products and crude oil. And Oneok estimates the deal will result in tax savings with a net present value of about $1.5 billion. We added to shares this week. Owned in Opportunity Portfolio.

Weekend Reading

Game on’ for Canada’s housing market? Spring 2023 increasingly looks like the turnaround point for Canada’s housing market after a year-long slump. RBC

Regret and Optimal Portfolio Allocations Not owning an asset or investment that subsequently outperforms could trigger an emotional response in an investor — regret, say — that resembles their reaction to more traditional definitions of risk. CFA INSTITUTE

The Water Brokers A small Nevada company spent decades buying water. As the West dries up, it’s cashing out. GRIST

Where Do Great Ideas Come From? Seven research studies reveal the people, incentives, and environments that create innovation.

Why Do Equities Build So Much Wealth? The single most common source of net worth for the ultra-rich is maintaining a highly concentrated equity portfolio consisting mostly of their shares in a company they founded. THE DIFF

“No matter how you cut it, you’ve got to own Cisco” (2000) One of the core philosophical beliefs I hold dear is that the future is inherently unknown and unknowable. BARRY RITHOLTZ

50 films we can't wait to see this summer From Barbie to Fast X, Oppenheimer to Asteroid City, Indiana Jones to Mission: Impossible, summer 2023 is promising to be a cinematic wonderland. MASHABLE



"The idea that the future is unpredictable is undermined every day by the ease with which the past is explained."

– Daniel Kahneman