Best of the Week
Most Popular
1. Gold Final Warning: Here Are the Stunning Implications of Plunging Gold Price - P_Radomski_CFA
2.Fed Balance Sheet QE4EVER - Stock Market Trend Forecast Analysis - Nadeem_Walayat
3.UK House Prices, Immigration, and Population Growth Mega Trend Forecast - Part1 - Nadeem_Walayat
4.Gold and Silver Precious Metals Pot Pourri - Rambus_Chartology
5.The Exponential Stocks Bull Market - Nadeem_Walayat
6.Yield Curve Inversion and the Stock Market 2019 - Nadeem_Walayat
7.America's 30 Blocks of Holes - James_Quinn
8.US Presidential Cycle and Stock Market Trend 2019 - Nadeem_Walayat
9.Dear Stocks Bull Market: Happy 10 Year Anniversary! - Troy_Bombardia
10.Britain's Demographic Time Bomb Has Gone Off! - Nadeem_Walayat
Last 7 days
Want To Earn A Safe 5% In Fixed Income? Buy Preferred Stocks - 24th April 19
Can Gold Price Rise Without a Rate Cut?  - 24th April 19
Silver’s Next Big Move - 24th April 19
How Can a College Student Invest Wisely? - 24th April 19
Prepare For Unknown Stock Market Price Action As New Highs Are Reached - 23rd April 19
Silver Plays a Small but Vital Role in Every Portfolio - 23rd April 19
Forecasting 2020s : Two Recessions, Higher Taxes, and Japan-Like Flat Markets - 23rd April 19
Gold and Silver Give Traders Another Buying Opportunity - 23rd April 19
Stock Market Pause Should Extend - 21st April 19
Why Gold Has Been the Second Best Asset Class for the Last 20 Years - 21st April 19
Could Taxing the Rich Solve Income Inequality? - 21st April 19
Stock Market Euphoria Stunts Gold - 20th April 19
Is Political Partisanship Killing America? - 20th April 19
Trump - They Were All Lying - 20th April 19
The Global Economy Looks Disturbingly Like Japan Before Its “Lost Decade” - 19th April 19
Growing Bird of Paradise Strelitzia Plants, Pruning and Flower Guide Over 4 Years - 19th April 19
S&P 500’s Downward Reversal or Just Profit-Taking Action? - 18th April 19
US Stock Markets Setting Up For Increased Volatility - 18th April 19
Intel Corporation (INTC) Bullish Structure Favors More Upside - 18th April 19
Low New Zealand Inflation Rate Increases Chance of a Rate Cut - 18th April 19
Online Grocery Shopping Will Go Mainstream as Soon as This Year - 17th April 19
America Dancing On The Crumbling Precipice - 17th April 19
Watch The Financial Sector For The Next Stock Market Topping Pattern - 17th April 19
How Central Bank Gold Buying is Undermining the US Dollar - 17th April 19
Income-Generating Business - 17th April 19
INSOMNIA 64 Birmingham NEC Car Parking Info - 17th April 19
Trump May Regret His Fed Takeover Attempt - 16th April 19
Downside Risk in Gold & Gold Stocks - 16th April 19
Stock Market Melt-Up or Roll Over?…A Look At Two Scenarios - 16th April 19
Is the Stock Market Making a Head and Shoulders Topping Pattern? - 16th April 19
Will Powell’s Dovish Turn Support Gold? - 15th April 19
If History Is Any Indication, Stocks Should Rally Until the Fall of 2020 - 15th April 19
Stocks Get Closer to Last Year’s Record High - 15th April 19
Oil Price May Be Setup For A Move Back to $50 - 15th April 19
Stock Market Ready For A Pause! - 15th April 19
Shopping for Bargain Souvenirs in Fethiye Tuesday Market - Turkey Holidays 2019 - 15th April 19
From US-Sino Talks to New Trade Wars, Weakening Global Economic Prospects - 14th April 19
Stock Market Indexes Race For The New All-Time High - 14th April 19
Why Gold Price Will “Just Explode… in the Blink of an Eye” - 14th April 19

Market Oracle FREE Newsletter

Top 10 AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

Is This What a Credit Bubble Looks Like?

Stock-Markets / Liquidity Bubble Apr 22, 2014 - 10:14 AM GMT

By: F_F_Wiley

Stock-Markets

There’s been some buzz recently about a pick-up in business lending. The six largest banks increased business loans at an average annual rate of 8.5% in the first quarter, according to a Wall Street Journal report last week. Other first quarter data reported by the Fed shows commercial and industrial loans jumping 12% from last year. Charles Schwab’s chief strategist went so far as to call a chart depicting the Fed’s broader lending data “the most important chart in the world.”


Unlike some pundits, though, we’re not convinced that a surge in business credit is such a good thing. We don’t doubt that more lending to small businesses, in particular, might do some good if it doesn’t go too far. Lending to large corporations, on the other hand, is a different story. Corporations are already borrowing at a pace that’s only before been seen near cyclical peaks:

debt to asset 1

At over 4% of GDP, you might say that borrowing is too high, not too low, especially as this pace never lasts long. The bigger issue, though, is that companies are choosing not to invest borrowed funds back into their businesses. You may have seen recent posts by David Stockman or Tyler Durden, breaking down financial statements for IBM, in particular. They showed that IBM’s borrowing in recent years was matched almost exactly by stock buybacks. Clearly, this isn’t the kind of borrowing that helps the real economy, and IBM’s not alone.

We’ll take a broader look at the use of borrowed funds with the Fed’s flow of funds data, which includes a measure of the internal funds generated by all US corporations. We add the internal funds figure (with an adjustment for dividends) to corporate borrowing to estimate the cash that’s available for all purposes: capital expenditures (capex) versus acquisitions, dividends, buybacks and other financial strategies. Normally, capex accounts for between 2/3rds and 3/4ths of the total. Here’s the latest update:

debt to asset 2

Needless to say, attitudes about capex aren’t quite what they used to be (see here for more discussion). Financial engineering now consumes almost half of available funding, with the implication that companies are piling more debt than ever before on each dollar of productive assets. Although debt-to-asset ratios for the broad corporate sector aren’t yet available for 2013 (the BEA doesn’t update fixed asset data until August), we can make a decent estimate using fixed investment data. Here’s a 60 year history with our 2013 figure tacked onto the end:

debt to asset 3

We pegged the debt-to-asset ratio at 65% in 2013, 6% above the housing boom peak of 59% in 2007. That’s a big jump in a short period of time. By comparison, the ratio also climbed 6% over the 11 years from 1989 to 2000, and barely rose at all from 2000 to 2007. Glancing at the chart just four years ago without the latest results, you might have guessed that leverage was finally leveling off. Apparently not. Together with weak capex, data describes a leverage-earnings-debt spiral that looks something like this:

debt to asset 4

The spiral could continue awhile longer, and probably will, but it’s not sustainable. The longer it circles in one direction, the more strongly it circles back in the opposite direction once the inevitable cracks appear in credit markets. In other words, not only does the spiral explain much of what we’re seeing in today’s financial markets, it also describes part of the process that leads to the next recession.

When will the debt super-cycle end?

What’s more, the data also begs the question: When does the roller coaster of leverage peaks and troughs fly completely off the tracks? The idea that we may be in the late stages of a debt super-cycle isn’t welcome in some circles, but the fact is that leverage can’t trend upwards forever. Eventually, we’ll reach a point where the normal reflation no longer works. We may then begin a secular downtrend (as in the period from the Great Depression to World War 2) or, at a minimum, we’ll establish a sideways pattern that fails to make new highs. Either way, the business cycle won’t look quite like it did over the last 70 years of rising leverage, nor will it look like the last few decades of increasing financialization.

Back to the question, can companies lever up as much as, say, 70% of assets? 75%? Maybe so, but it says here that the super-cycle ends well before debt reaches 100% of assets. It’s hard to say exactly where the breaking point is, but we’ll continue to share clues as we find them. In the meantime, one clue may be the bursting of the mortgage bubble in 2008. As you look at the last chart below, keep in mind that residential mortgage debt (backed by properties) and corporate debt (backed by productive assets) are fundamentally different. Or, maybe they’re not so different? You decide.

debt to asset 5

Sidenote: Regular readers know that we’ve already taken a position on critical thresholds for government debt. See our Fonzie/Ponzi theory and follow-up posts here and here.

(Update: Note that the fixed investment and fixed asset figures used in the charts include intangible investments such as R&D, software and entertainment/artistic assets, per new methodology implemented by the BEA last year.)

F.F. Wiley

http://www.cyniconomics.com

F.F. Wiley is a professional name for an experienced asset manager whose work has been included in the CFA program and featured in academic journals and other industry publications.  He has advised and managed money for large institutions, sovereigns, wealthy individuals and financial advisors.

© 2014 Copyright F.F. Wiley - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules