Keep in mind, business loans as a percentage of GDP are higher now than at August of 2000 and at August of 2007. The use of leverage by households, government, financial companies and non-financial companies was certainly out of control at those moments in history. What’s more, the leverage extremes of the past led to credit cycle and business cycle . It follows that it may be reasonable to assume that credit contraction is likely to occur soon enough.
In fact, extremes in the use of leverage tend to downshift at the least opportune times. Fewer borrowed dollars would mean less money for productive purposes (e.g., plants, equipment, human resources, , etc.) or for immediate investor (e.g., share buybacks, dividend increases, etc.).
Some may believe that central bankers are more prepared for a severe pullback in credit today. Perhaps they would turn toward an even larger open-ended quantitative easing (QE) program or implement a policy of negative interest rates. The only problem is, corporate bond issuers are already seeing diminishing benefits of lower yields. The Fed, the Bank of Japan, The European Central Bank may be eager to promote lending at a time when they see a need for more stimulus, but it may not matter if households and corporations are fearful of additional borrowing.
It should come as no surprise, then, that companies with the highest-rated financial health have outperformed the S&P 500 SPDR Trust (SPY) in 2015. Whereas buyback “achieving” corporations have been sliding via the PKW:SPY price ratio above, the iShares MSCI USA Quality Factor (QUAL):SPY price ratio has been rising throughout the year.
Binge borrowing by corporations may not be a death knell for the bull market in stocks. Nevertheless, when one factors earnings declines and revenue declines into diminishing benefits from ultra-low borrowing costs, one may find it less lucrative to buy every dip.
Disclosure Statement: Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at he ETF Expert website. ETF Expert content is created independently of any advertising relationship