ONE DEFAULT FROM DISASTER
It’s easy to feel like we’re out of the woods. Fears of a bear market have subsided. Most people think that recessions cause the stock market to tank. And by most indicators, there’s no immediate risk of a recession today. As long as the economy continues to grow and unemployment remains low, you should stay invested in stocks. You don’t have anything to worry about... right? Not necessarily... I believe one thing will trigger both the next recession and the next bear market. In fact, the next stock market collapse will likely happen before the next recession begins. It will happen suddenly, and most investors won’t have time to react. Today, most people are looking in the wrong place for the warning signs... They’re focused on the rate of unemployment and inflation... the U.S. Federal Reserve’s interest rate changes... and corporate earnings. But the real warning signs will come from the same place that caused the last financial crisis: the credit market. The credit market is where all types of debt – government, consumer, and corporate – are bought and sold. Because the credit market isn’t as exciting as the stock market, investors often ignore it altogether. It’s critical to understand what’s happening in credit. Remember how the last financial crisis began? One type of consumer debt (subprime mortgages) started going bad, causing a massive sell-off in the troubled loans. The credit market drives our entire economy... It’s highly cyclical.
When interest rates are low and credit is cheap, we experience “booms.” When rates rise and credit tightens, we experience “busts.” Since the last financial crisis, credit has been cheap and easy to access. And during the current credit cycle, the biggest excesses have occurred in corporate debt. When this corner of the credit market starts to turn – as more and more high-yield (“junk”) corporate debt goes bad – it will kick off the next crisis... and most investors are oblivious. Since the last financial crisis, companies have gorged themselves on cheap credit. Yield- starved investors have gobbled up this debt in record numbers... U.S. corporate debt has ballooned to $9 trillion today, roughly double the amount from 2007. In the preceding chart, you can see that
corporate debt is at all-time highs – both nominally (blue line) and as a percentage of GDP (red line)... But it’s not just the sheer size of corporate
debt that’s troubling... It’s also the quality. The largest portion of this debt today – a record $3 trillion worth – is
rated as the lowest level of investment-
grade debt, one level above junk
status. Meanwhile, companies are even
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April 2019
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