In this article, I will discuss the findings posted in the IMF’s Global Stability Report and some of the latest economic statistics. The IMF’s report was shocking as it has graphs that look like what economic realists like John Hussman and David Stockman publish. When the bearish narrative leaks into government reports, you know the situation is dire as the government has a bias towards being positive. I consider the current period to be the ultimate test in intellectual integrity. If you don’t think stocks are expensive when the S&P 500’s price to sales ratio is the highest ever, you clearly ignore facts. The debt in the economy and valuations are making the decision to be bearish as easy as it will ever get.
The chart below shows the debt bubble I’m discussing. Low interest rates combined with index fund investing has distributed the bubble more evenly than the prior two bubles. Therefore, the median net debt to EBITDA of S&P 500 firms is near the all-time high. The mean debt to EBITDA isn’t at the level of the 1990s tech bubble because a few technology stocks pushed the average higher. The median is more important than the mean in this statistic because it reflects the percentage of firms which have too much debt. Although the mean isn’t important to judging the size of the bubble, it’s usually a good signal for when the economy turns. It has fallen in every recession besides the one in the early 1980s. It has had a few mid-cycle dips but usually when the dip continues a recession either happened or is about to happen. This makes the latest dip notable. It makes sense for the debt to EBITDA to peak after the recession starts because earnings fall during recessions. Recessions are caused by a deleveraging, so the ratio eventually falls.
The fact that the recession hasn’t started and the median debt is so large is disconcerting because the mini earnings recession of 2015-2016 will look like nothing when a real recession occurs. Finally, you can see the pause in the debt increase when energy is included because of the crash in oil prices in 2014 and 2015. Lately the debt has flowed back into energy as they have lowered their breakeven costs making it profitable to drill with oil in the low $50s.
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