Times are a-changing: debt and investment returns
By Nektarios Michail
The last decade has been extremely good for most investments, especially those with higher risk. As the table below shows, investments in any diversified high-risk investment product yielded significant returns. For example, the S&P 500 index yielded approximately 14 per cent per year, with investments in US real estate yielding 7 per cent, excluding rental income.
In Europe, the Eurostoxx 50 index gained approximately 8.5 per cent per year, with the Greek stock market yielding approximately 7.2 per cent per year. We discuss in this article the linkages between macroeconomic drivers and market increases in past and future. This is for informational purposes only and is not financial advice or investment advice.
This year, as shown in the Table, returns continue to be high. A striking example is gold, whose price has risen by 52.7 per cent in 2025 alone, year-to-date, while the Greek stock market index and the Chinese stock index have also performed exceptionally well. Even products such as 10-year US bonds, which are considered low risk, have recorded a return of 7.3 per cent this year.
The reason for showing the returns on these investments, as well as the comparison of the previous decade with 2025, is to emphasize that past returns are always indicative of the prevailing macroeconomic factors during that period.
One of the main factors that has influenced the markets in the past decade was public debt. In the US, the world’s largest economy, public debt skyrocketed from around $8.5 trillion in 2005 to $35 trillion in 2024. Despite economic growth over the last 20 years, the debt-to-GDP ratio has almost doubled, reaching 120 per cent.
The large increase in public debt, resulting from increased government spending, clearly means that the amount of money in the economy has increased significantly. This implies greater disposable income for households and businesses, as well as increased investment capacity. Therefore, the rise in international stock markets is no coincidence: from 2005 to the end of 2007, when US debt increased by only 10 per cent and the debt-to-GDP ratio was stable, the S&P500 index recorded an average annual increase of around 8.6 per cent, significantly lower than the 14 per cent increase recorded over the last decade.
However, it is difficult for such a large increase in debt to continue without consequences. When the US had a debt-to-GDP ratio of around 66 per cent in 2005, there was fiscal space to increase debt in a period of crisis, which is what happened in 2008. However, when the crisis ended in 2009, the increase did not stop, and as a result, the fiscal space has been eliminated. Now, with a fiscal deficit of almost 6 per cent, the US needs to react – the only correct response is to reduce the deficit, which is expected to affect the markets.
This increase in public debt has not only been observed in the US. In China, now the world’s second-largest economy, debt skyrocketed from $600 billion to $16.5 trillion between 2005 and 2024, mainly with the aim of supporting the domestic market, particularly during a period when the real estate sector was facing many problems, but also with the aim of internationalising the country to increase its geopolitical power. Although this goal has largely been achieved, China’s fiscal space is also shrinking. With a debt-to-GDP ratio exceeding 95 per cent in 2025, fiscal space is narrowing, although it is still greater than in the US. However, the fact that China still relies heavily on exports rather than domestic consumption, albeit to a lesser extent than in the past, makes it more vulnerable to potential problems in its external environment.
Furthermore, among the major European economies, only Germany has managed to keep its debt relatively stable over the past 20 years. Even in this case, the country’s debt has increased from $1.9 trillion to $3 trillion. In contrast, France’s debt more than doubled, while the UK’s more than tripled. In Italy, as debt was already high, the increase was smaller. With the exception of Germany, the debt of the other three countries (the United Kingdom, France, and Italy) far exceeds 100 per cent of GDP. Although Italy’s debt-to-GDP ratio is the highest, France is in the worst position with huge budget deficits and great difficulties in reducing them.
What the above highlights is the major increase in liquidity over the last 20 years; much of that liquidity has entered global markets and has aided in increasing risky investment returns. However, as markets rely on a continued inflow of cash to maintain their upward trajectory, a change that reduces overall flows is expected to have a negative impact, reducing returns from the levels we have seen over the last decade. As the United States is expected to gradually reduce its fiscal deficit, with recent data showing an increase in revenue from trade tariffs and a reduction in education spending, it is reasonable to expect a normalisation of returns, both domestically and globally. In the case of other countries reducing their deficits, the impact is expected to be more localised, although possibly lasting for a longer period.
Another important factor affecting the markets over the past decade was the stance of monetary policy. Although the role of interest rates is often not emphasized enough by many analysts, a significant reduction or increase in interest rates can significantly affect the returns on many financial products. A recent example was the increase in interest rates in 2022-2023, in an effort to counter the effects from rising energy prices, which led to negative returns on global financial markets in 2022.
In the previous decade, zero interest rates in the US and negative interest rates in the eurozone helped stock markets to rise. More importantly, they mainly helped over-indebted governments avoid sustainability problems by keeping debt costs at historically low levels.
However, that period is now irrevocably over: the European Central Bank’s interest rate stands at 2 per cent, with markets not anticipating any further change in interest rates until 2026, while the Federal Reserve’s interest rate is expected to fall from its current levels, but at a much slower pace and remain higher than before. Most importantly, neither the US, the eurozone, nor the UK are expected to return to zero interest rates unless there is an economic crisis.
In summary, it appears that the main macroeconomic factors that drove the world’s markets to the spectacular increases we have observed over the last decade have now changed. High debt levels require immediate changes, which, combined with higher (though not as restrictive due to increased liquidity) interest rates, are expected to normalize the returns on high-risk investment products, while the returns on low-risk investment products will now be much more competitive.
Nektarios Michail is Economics Research Manager at Bank of Cyprus. Views expressed are personal. The article is republished from the blog of the Cyprus Economic Society.