This Bull Market Is Built on Debt
Melbourne, Australia
Monday, 28 June 2021
Twitter: @CallumRN [3 min read] Junk bonds hit dubious record Margin lending juices US stocks Plus, gold analysis says buy now Dear Reader, 1. Our job in the market is to find discrepancies and opportunities to make money. But we also have to keep an eye on the whole edifice to make sure the thing isn’t going to come crashing down around us. I picked up on the following in The Economist last week. So called ‘junk’ debt is going bananas in the US. What’s this? ‘Junk’ debts are bonds that high-risk companies issue and are considered below ‘investment grade’. Generally, they pay much higher returns because of this riskiness. The Economist reports that COVID-19 didn’t wipe out as many leveraged borrowers as other recessions in history because the Federal Reserve was throwing around so much money. It allowed companies to refinance or stay afloat. But it means a good chunk of American companies are now more indebted than ever, some of which are in the record books for debt relative to their earnings. Low interest rates and a booming US economy means this may not be a problem now. But if either of these dynamics change, then the market may get the wobbles. I don’t overly stress about this. Trying to ‘read’ the junk bond market for signs of a market top has been a distraction over this entire bull market since 2009. I remember doing an interview with a colleague around this in 2016. He was of the view that the credit cycle would turn bad around that time…and a lot of highly leveraged borrowers would go to the wall. But interest rates and the ‘zombification’ of the credit market kept the bear at bay on this issue.
That’s what happens when you have a central bank buying up bad debts all the time. Market dynamics don’t work in the same way. And just on that…part of the recent wobble in the stock market was the idea that the Federal Reserve would start to ‘taper’ its bond buying. However, there’s no evidence of it happening yet. Two weeks ago, the Fed balance sheet was around US$8 trillion. I checked the update this morning…and it’s risen another US$150 billion. How long the Fed continues to blow these asset bubbles sky high is anyone’s guess…but don’t ever be fooled into thinking it’s built on anything but debt and money creation. Margin debt (money lent to buy shares) is at a record high in the US as well. I saw this chart back in April on this: This is why fear in the market becomes palpable when the spectre of inflation and interest rate rises come closer. That would cause the punchbowl to go away. I don’t know about you, but I’m happy to invest in the market for now. But there’ll likely come a time in the next 12–18 months to go conservative. Stay tuned for updates on this. | 