The U.S. is headed for a major debt crisis due to its fiscal deficit being at the “worst structural point since World War II,” according to value investor Matthew McLennan. McLennan, co-head of First Eagle’s Global Value team, said equity and bond markets are showing signs of “relative complacency” and are yet to digest the full impactions of the country’s borrowing program. U.S. government’s spending has exceeded the amount it has collected in tax revenues by $1.5 trillion over the past year – or by 5.5% of the country’s GDP. McLennan noted this is “highly unusual,” saying usually, budget deficits contract near the peak of the economic cycle. Over the past two decades, the federal government had its smallest budget deficit of $0.16 trillion in 2007, just before the global financial crisis. Prior to that, the U.S. had a surplus before the dot-com bubble burst in the early 2000s. The risk McLennan, who also manages First Eagle’s Global Fund , believes the fiscal stimulus has “been a big part of that story” of resilience in the U.S. economy so far, which has helped push up stock prices to near all-time highs. However, he warned this also presents a “substantial risk,” such as a deficit of around 10% of GDP if the economy heads into recession. “The question that I think markets have to ponder at some point is, ‘is there a credible path to getting that 10% deficit back towards a two or three percent of GDP?’,” McLennan said. He sees it as “hard to imagine” the political will emerging that will curb government spending in the medium to short term. He pointed to inflation-linked entitlements as a key driver of government spending, saying: “There’s really no bipartisan discussion about entitlement reform in the United States.” Social Security benefits and contributions are linked to changes in inflation over time and rose by 8.7% to about $1.4 trillion this year. The hedge Given his bearish view, McLennan prefers gold as an investment hedge. He said gold has held its value recently while alternatives like sovereign bonds have collapsed in price. Traditionally considered a risk-free asset and used in portfolios as a hedge against losses in equities, bonds have performed poorly over the past year. For instance, the $40 billion iShares 20 Plus Year Treasury Bond ETF has declined in value by 16% this year to compensate for the rise in yields due to sticky inflation. However, SPDR Gold Trust ETF has stayed nearly flat year-to-date. “Gold hasn’t offered stunning upside like an A.I. stock, but as a potential hedge asset, it’s held its value when the alternative of nominal sovereign bonds has been marked down severely,” said McLennan, whose First Eagle Global Fund has allocated nearly 11% toward the shiny metal. “Gold as a potential hedge tends to play out over the longer term, but if you’ve looked at the worst decades for equities over the last century … those were the best decades for gold,” McLennan explained. “We’re not looking for something that’s going to work over the next quarter per se, but like something that could be a structural source of ballast over a longer-term period, and that’s what we think we have in gold,” he added. McLennan believes gold will likely start appreciating “when the interest rate cycle turns down.” He said gold historically peaks when yields trough, which has not happened yet in this cycle. Yields, in fact, reached their 16-year highs this week. 10-year Treasury yield rose as high as 4.884% on Tuesday — levels last seen in 2007. Stocks Beyond gold, McLennan said he sees value in stocks like Meta and Oracle , two of the top equity holdings in the Global Fund. He explained Meta became undervalued earlier this year amid concerns over its spending on the metaverse, trading below 2x revenue at one point. The social media giant’s shares had tanked 64% in 2022. “The valuation at its trough was quite compelling,” McLennan said, adding that the multiple remains attractive. The stock has rallied by 150% this year. McLennan said his fund has owned Oracle since it launched an AI-powered database five years ago. He said Oracle and other companies in the portfolio use AI in their specific applications and benefit from the technology without paying high multiples. Companies identified as primary beneficiaries of AI, such as Nvidia , have rallied this year. Microsoft ‘s association with ChatGPT-maker OpenAI has also helped push its stock by 30% this year. “It’s not enough to find a good business. You have to find a business that’s better than other people think it is,” McLennan said, suggesting he sees value in Meta and Oracle based on their cash flows and market dominance.