Tue Aug 20, 2019, 03:19 PM

Corporate debt, rate cuts, and the stock market.

The amount of corporate debt has increased substantially in the last decade.The graph below shows how leveraged loans have more than doubled since 2006. This is not a financially healthy situation.

"Of course, many of these bonds are simply financial engineering to buy back stock to increase earnings per share. Uber-low long-term interest rates thanks to QE have allowed companies to do this cheaply.

The FED must have realized that raising interest rates to 3% or over would have resulted in such a large amount of debt becoming unsustainable and turned dovish in March 2019.

It is important to understand that companies have concentrated on financial engineering to boost stock prices by implementing share buyback programs that have been financed by debt. The capital has not been invested in R & D (Research and Development) or in Capex (Capital Expenditure) in order to strengthen the company and make it more resistant to a crisis or recession. Capital has been grossly misallocated, and the economy is basically weaker than it should be and therefore more prone to suffer disastrously when there is an economic downturn.

Then there is the shale oil Ponzi scheme to be considered in the context of corporate debt. Even with an oil price over $60 small and medium-sized producers are still going to have to cope with negative cash flows. As the oil majors crowd into shale oil, they too will find that the rate of well depletion is so high that continually more capital is required to keep production at a high level. The amount of debt owed by the shale oil producers is extremely high. At a certain point investors are going to stop financing operations that are cash burners just as investors have begun to tire of the hype over Tesla automobiles.

Fear of widespread defaults could cause investors and banks to be unwilling to finance zombie companies and those with negative cash flow. An economic slowdown could crimp company profits and slow down the rate of corporate share buybacks,

The federal debt is increasing at a fast pace, and the Treasury is going to need a lot of money to cover budget deficits. The government could thus soak up significant amounts of liquidity as it covers its need for cash. Of course if the market does not come up with liquidity, the FED could always buy Treasury paper,

If that is what will be necessary to avoid a liquidity crisis and the ensuring credit crunch that would result, it will be interesting to see how far the FED will go.

Please understand this is the a look of how things are today. So you have a better view of what supports the price of the stock market. Why the FED may lower rates is not solely about the trade war with China.

The FED can do so much with rate cuts. It can not prevent a down turn in the global growth cycle. As growth in the global economy slows, liquidity slows, lending slows and stock markets contract.

Taken together, the trade war and the slowing of the economic cycle, it's like watching Humpty-Dumpty on the proverbial wall.

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Reply Corporate debt, rate cuts, and the stock market. (Original post)
uncledad Aug 2019 OP
BigKahunna2.0 Aug 2019 #1
uncledad Aug 2019 #2

Response to uncledad (Original post)

Wed Aug 21, 2019, 05:08 PM

1. A very well thought out analysis ..... Have to pay attention in this enviroment... Thrive!!

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Response to BigKahunna2.0 (Reply #1)

Wed Aug 21, 2019, 10:18 PM

2. ...

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