Yesterday, the S&P 500 logged in as the 3rd longest bull market in the benchmark’s history. Yes, yes… bull market’s don’t die of old age. Yet, what about health-restoring corrections of 10%? Shouldn’t they appear more regularly than 45 months (1371 days)? The current period of equanimity now registers as the 3rd longest without a 10% pullback.
In my recent article on the debt-driven economic expansion, I focused on the Federal Reserve’s acquisition of $3.75 trillion of the public treasury debt with electronic dollars (a.k.a. “credits”). Naturally, record-low yields enticed families to borrow more money; they bought real estate and stocks through their 401ks, pushing prices higher and making households feel wealthier. More critically, however, corporations borrowed by the boat-load to finance similar acquisitions. In fact, non-financial companies currently owe 37% of their net worth. That’s greater than the 34% leverage witnessed back in 2007.
Some folks might argue that 37% really isn’t that big a deal. After all, it represents an improvement over a 45% debt-to-net-worth ratio in 2009, doesn’t it? Not exactly. When asset prices inevitably decline – perhaps by an average bear of 29%-30% – net worth will drop dramatically while the debt will remain the same. In this manner, the typical corporation may be a bit like an emperor wearing little more than his undergarments.
Corporate debt yields have skyrocketed as of late. The iShares Intermediate Credit Bond (CIU) sits at the farthest point below its 50-Day moving average than at any other moment in 2015.
Does the near-term direction have anything to do with a lack of faith in the ability of investment grade companies to service their obligations? Not likely. Panic selling of sovereign debt, primarily in German bunds, but also with U.S. treasuries, contributed to the bond repricing. Add in a reversal of the euro carry trade, and owning U.S. dollar denominated treasuries became hazardous. Year-to-date gains for the iShares 7-10 Year Treasury ETF (IEF) have been nearly wiped out.