Nobody knows when the markets will crash, but this Everything Bubble is ready to pop with these 3 signs that happened during previous recessions. These indicators are flashing red so watch the video and be prepared no matter when the bubble might burst!
-Why The Everything Bubble Will Burst Intro
-Recession Sign 1
-Recession Sign 2
-Recession Sign 3
-Black Swan Event That Pops The Bubble?
-How To Prepare No Matter When The Bubble Bursts
With the stock market and real estate prices at all time highs along with 7% inflation, it feels like the prices will just keep going up forever, right? Like we learned during the Great Financial Crisis or the end of the Housing Bubble, real estate prices don’t go up forever, and neither do stock market prices. They eventually reset and the cycle repeats.
The unprecedented amount of money printing has led to extremities in the market, where we’re seeing inflation not just in the everyday goods we buy, but also in the prices of assets like stocks and houses.
Who knows if markets will come crashing down in 2022 or 2023 as some are predicting, like Elon Musk or Harry Dent, but it seems like the amount of monetary liquidity in the markets is a giant house of cards that could fall apart at any moment.
Even though we tend to get wrapped up in the amount of government debt and the extent of monetary and fiscal stimulus because these topics get talked up the most in the media, the truly worrisome factor is the sheer amount of corporate debt that could be leading to the everything bubble. This is why the next recession or depression will matter so much, and why the current Roaring 2020s are rhyming a lot with the original 1920s.
Even though we briefly flirted with a bear market and recession in March 2020, it wasn’t the actual true end of a long term credit cycle, so it wasn’t likely going to lead to a legit market reset (borrowing from Howard Marks’s thought process). So it probably wasn’t the beginning of a real recession, yet.
There are likely other signs that will lead to a real recession happening sooner than later. And while these 3 signs I discuss may or may not be causal, they are definitely correlated with the next recession.
The first sign of the next recession is US income inequality. The US has the highest level of income inequality among many first world nations, and the highest earning 20% of families made more than half of all US income in 2018.
The levels of income inequality are almost as high, if not higher than the levels we last saw during 2007 and the late 1920s. It’s also manifested in the annual income share going to the top 1%, and in the Great Recession it registered around 23.5%, and in the Great Depression it was at 23.9%. In doing some proportional math using real annual wage percent changes, I arrived at the current level in 2020/2021 of 27% going to the top 1%! Bloomberg confirms this in showing how the top 1% held more wealth at 27% compared to the middle 60% holding 26.6% as of June 2021. This is the highest level of income inequality ever.
The next recession’s second sign is corporate debt. The overall nonfinancial corporate debt as a share of GDP is as high as it’s ever been, and much more than during 2007 or 2020. At face value we know that corporate debt tends to spike before recessions, but there’s much more than meets the eye beneath this iceberg of titanic size of corporate debt.
Previous bubbles and subsequent recessions seem to happen at the peaks of credit cycles, as we can see with the 1990 recession, the dot com bubble and 2000s recession, and the 2007/2008 Great Recession. Many charts have been pointing to a possible credit cycle peak since 2018 and carrying into 2022.
Some of the reasons corporations might take on corporate debt is to fund operations, research and development, growing their workforce, or investing in certain ventures to hopefully grow more profits. This can benefit the economy, society, and shareholders.
And some of the ways in which corporations might get debt is either by getting bank loans or issuing corporate bonds. Companies favor getting debt financing through corporate bonds more than loans or issuing equity because that would dilute share prices.
Corporate bonds can finance a lot of things, but a lot of companies’ bonds have been declining in their ratings quality. More corporate bonds are losing investment grade status and going into junk bond status.
Some of the reasons why companies are bulking up on corporate debt is not only to fund operations, but also to fund a potentially insidious reason as the third sign (and maybe one of the most salient reasons) as to why the next recession will happen.
Before we get into the third sign, you should understand what liquidity is and how that can lead to credit risk. For years, the Federal Reserve had kept interest rates low in the aftermath of the Great Recession in order to encourage consumer and corporate borrowing and spending.
So as companies took advantage of issuing corporate bonds in a low interest rate environment, this meant that many companies could more than afford the interest payments on their corporate bond debt.
By taking on a lot of cheap debt, companies have a lot of liquidity. But then if The Fed starts raising interest rates, that starts making interest payments harder on these corporate bonds. If the interest rates are high enough, then corporations are discouraged from issuing too much corporate bonds and borrowing too much debt. So they start reducing the amount of debt they are taking on because their financial obligations are becoming more meaningful and eating up more of their cash reserves.
If their operations aren’t generating enough profits or cash flow to afford their debts, then that’s not a good sign. Having a lot of credit will actually lead to companies running into credit risk where they have too much debt, and if they don’t have enough cash to be solvent, to afford all their debts, then that’s where you can have credit risk. There is an increasing risk of default on their debt obligations. Too much liquidity could be a double edged sword.
When we start having an economic downturn like we did in 2020, The Fed wanted to encourage borrowing and spending because one person’s spending is another person’s income, and this is how our US economy goes round. So The Fed not only lowered interest rates to near 0%, but they also bought US treasury bonds, mortgage-backed securities, and for the first time ever, corporate bonds!
With The Fed now seeing inflation rising way beyond their 2% target and employment reaching closer to normal levels, they began to taper their bond purchases and sell off their corporate bond holdings to try to reduce higher than expected levels of inflation. The Fed may raise interest rates as early as March 2022, which spooked markets and caused a little sell-off so far.
Over the last couple of years and for many years leading up to now, corporations flush with liquidity and credit from their cheap debt have been doing the third sign, which is stock buybacks or AKA share repurchases!
Stock buybacks are the main source of the rally behind the epic bull market that we have had since 2009, and this is a pretty big deal!
This third sign of stock buybacks was an epiphany to me because I’d been trying to figure out the puzzle of why the stock market keeps hitting all time highs in the face of weak economic growth over the last decade.
A large part of the rise in the stock market can be attributed to S&P 500 companies buying back $5 trillion of their own companies’ stock. So it’s no wonder that the stock market has been rising incredibly alongside buybacks and to a lesser extent, dividends.
Stock buybacks have been hitting record highs such as $806 billion in 2018, declining somewhat in 2019 and 2020, before reaching the next record at $850 billion in 2021!
Back in 2018, some analysts had said that “companies buying back their own shares is the only thing keeping the stock market afloat right now.” If that was the case in 2018, it could also be the case in 2021 going into 2022. So the source of the S&P 500’s record highs could be due to record levels of share buybacks and debt.
This is concerning because corporate profits used to go to funding operations in the form of spending in capital expenditures, but now a lot more profits are going into share buybacks and dividends. If there’s too much of this, then there’s a lot less future development of companies, and then they might stagnate, and not be as competitive in the world market.
This is why buybacks have become especially controversial with the looming Congressional threat of taxes levied onto buybacks, but they can be good sometimes as I’ll explain with what Warren Buffett thinks about buybacks.
You may have noticed that Berkshire Hathaway has been increasing their stock buybacks over the last couple of years, so that might make you think that doing buybacks is a great thing. But Warren Buffett warns in his 2012 annual letter, “But never forget: In repurchase decisions, price is all-important. Value is destroyed when purchases are made above intrinsic value. The directors and I believe that continuing shareholders are benefitted in a meaningful way by purchases up to our 120% limit.”
In Buffett’s 2020 letter, he continued, “In no way do we think that Berkshire shares should be repurchased at simply any price. I emphasize that point because American CEOs have an embarrassing record of devoting more company funds to repurchases when prices have risen than when they have tanked. Our approach is exactly the reverse.”
So Buffett must think that Berkshire Hathaway is trading below its intrinsic value, so there must be somewhat of a margin of safety even though Berkshire has been trading at its all time highs lately. Maybe it’s good to keep doing stock buybacks for Berkshire, but this isn’t necessarily the case for other companies.
With Apple hitting a $3 trillion market cap, they have been doing hundreds of billions of dollars of stock buybacks over the years. So it’s no wonder that their stock price has been skyrocketing to the moon.
Apple and Berkshire Hathaway are among the top 10 buyback queens lately, but if we remove these top 10, it looks like many other companies have been starting to slow down with their share repurchases. So who knows what that could be foreshadowing of things to come as more companies are doing less debt-financed buybacks as the interest rate environment starts getting less favorable.
And it’s probably not a coincidence that stock buybacks happen when stock prices are at their highest, and now more than half of all stock buybacks are financed by debt. They used to be financed by cash, but they are increasingly financed by debt.
All of this is leading to a strong correlation between buybacks and recessions!
While we had seen a lot of retail investors then institutional investors coming into the markets in recent years, now we’re starting to see the smart money and retail money flow out of the markets. The only thing that seems to be propping up the markets could be the stock buybacks.
So it begs the question, what could be the black swan event that finally pops the buyback party and everything bubble? Even though we had 2020, that wasn’t enough to cause corporations to be scared enough to stop their buyback programs.
If we look back to Q4 2018, a lot of companies did a lot less stock buybacks when interest rates seemed to be just high enough that it made having debt not as attractive. So that’s what seemed to cause the market to go down in the fourth quarter of 2018 as interest rates became discouraging enough.
So I’m wondering: what will be The Fed interest rate that will make corporations not want to take on as much debt as they had before? According to WSJ reporting, “investors brace for slowing corporate bond sales” as “analysts estimate that bond supply from financial companies will fall 30% in 2022, led by declining bank issuance.”
Companies taking on so much debt is becoming more unsustainable, the more it just keeps dragging on. I think there will be a straw that will break the camel’s back, or knocks over the house of cards that is the titanic amount of debt that corporations had taken on. It’s not great to crash into an iceberg but it’s good to be prepared.
One of the ways we can prepare is by reading Ray Dalio’s “Big Debt Crises,” and trying to understand what makes for a long term credit cycle, or why a short term credit cycle might burst. It’s good to be as prepared as we can be, no matter when the bubbles might burst!
If you’re interested in learning how to take control of your finances and start becoming an investor like Warren Buffett, check out my free PDF guide.
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