Turbocharged Debt Cycle Won't End Well

This turbocharged debt cycle will end miserably — it’s just a matter of when

David Rosenberg

There have probably never been as many characteristics of a top as we are experiencing today. At some point, as unpopular as contrarianism can be, we all need to ponder deeply about Bob Farrell’s Rule #4:

“Exponentially rapidly rising or falling markets usually go further than you think but they do not correct by going sideways.”

No one really knows how far up the top is, but what happens after the top does not fit into very many people’s risk tolerance. In the meantime, another year of double-digit returns on the highest quality, long duration bonds is our expectation and the interest rate risk associated with them is entirely manageable from my perspective as a market economist.

While I cannot pick the date, I can tell you that this turbocharged debt cycle will end miserably, not unlike 2008 and 2001. Don’t try to time the inevitable mean-reversion trade. Just heed this first Bob Farrell rule of investing on ‘mean reversion’ and know that it’s out there. In nearly 11 years the S&P 500 has soared nearly fivefold to multiples (on earnings, sales and book value — take your pick) we have only seen twice in recent history.

The ratio of corporate debt-to-GDP is at all-time highs. In addition to the unprecedented fiscal stimulus at this late stage of the economic cycle, and accompanying trillion-dollar deficits, we also have corporate leverage ratios at record levels. An enormous volume of corporate debt has been issued exclusively for the purpose of buying and retiring shares. This includes both buybacks and acquisitions of other companies. And in classic mature-cycle fashion, we are seeing some cracks emerge in the junkiest parts of the U.S. credit market. This is an area to be focused on as leveraged credits are in an eerily similar situation to what was surfacing out of the subprime mortgage market back in 2007.

In 2020, I smell a rat. The central bank liquidity taps are likely to be turned on even more, but the impact at current valuation levels across the various risk asset classes will be far more muted now than was the case a year ago. And there is always the prospect that the monetary authorities will stay on the sidelines and await a budgetary tax cut or government spending response, which itself is futile given that fiscal policy in most countries is just as tapped out as monetary policy.

There are no easy solutions and it is doubtful that we will have another year where central banks can transform the weakest period for global economic growth in a decade and pull another rabbit out of the hat in terms of massive excess returns for equity and corporate bond investors.