Is This Bull About to Charge off a Cliff?

You have permission to back up the truck and buy with both hands – for now.

That’s because the International Monetary Fund’s latest Global Financial Stability report has given traders the “All Clear!” signal.

At least until 2020.

You see, that’s the year a debt crisis hits the global economy, at least in an IMF simulation. In the game theory exercise, the crisis sends tremors through the financial system and asset markets.

The simulation is probably more of an exercise in risk prevention than it is a forecast. Still, the lessons of the crisis simulation are worth heeding.

Just not yet.

That’s because everyone seems to have capitulated to this market: “The market IS going higher.” And understandably so.

The bull is raging at a time when simultaneous global growth seems to be unveiling a sustainable, expansionary environment.

Overall, I tend to agree.

But I can’t ignore the biggest risks or the looming potential for a significant correction .

For now, consider U.S. corporate debt …

An author at CNN Money just announced that America was “great again” before Donald Trump was elected president. He declared American corporations were already “great again.” He added: “The bad results are the exceptions, not the rule.”

It’s hard to argue otherwise. Earnings growth has been solid since last year despite how many times I’ve pointed to corporate debt levels that are frothy, to say the least.

Well, to that point, I came across an intriguing chart this week: U.S. corporate debt as a ratio of cash flows.

Conceivably, debt is not a problem if it can be financed.

That’s why my concern, and the concern of The Edelson Institute, has always been on what might happen to alter the capacity of a company, municipality or country to service its debt.

An expansionary environment bodes well for financing.

That is unless corporations are short on cash when financing costs – interest rates – rise. Or when liquidity dries up.

And – almost as though I planned it this way – on a historical basis, corporations today are short on cash relative to debt.

An era of low interest rates has made that trend sustainable. The compression of credit spreads is indicative of the impact low interest rates are having on the riskiness of companies.

And that’s a risk, since the market is not pricing credit appropriately relative to corporate debt/cash ratio.

We may not get a recession, but we don’t need one for those credit spreads to widen.

All that needs to happen is for the markets to react adversely to volatility, rising interest rates or their own shadows, for that matter. That’s because selling can beget more selling, and so on and so forth.

If liquidity recedes and credit spreads widen, suddenly Corporate America doesn’t look so great again.

The bulls are running. Beware a snapback to put irrational exuberance back in its place.

Do right,
JR Crooks

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