Leverage

Share prices rise when more money joins the market, and they drop when money leaves the market. That money comes from somewhere and goes somewhere. In the first case, the money may come from the sale of property, from dividends, interest, unspent wages, windfalls, or borrowing. In the second case, the money may be consumed, invested elsewhere (real estate, gold, abroad, etc.), or used to pay back debts. These last few years there has been a lot of borrowing at low rates of interest. However, “Free credit” (Proudhon) still has to be paid back. When all those debts reach their terms, they will have to be renewed, reimbursed or defaulted on. Their renewal will be more costly, as interest rates are rising and that movement will probably accelerate. Their reimbursement will take money off the market and improve bank balance sheets. Their default on a large enough scale will push banks over the brink. As for corporate debts, which are historically huge according to the Federal Reserve (1), a good proportion has been used to buy back shares, thereby reducing the number in circulation and provoking a rise in their price. If that debt is renewed at a higher cost, it will reduce company profits. Paying it back will require large amounts of cash that can only be obtained by selling shares and debasing their value, after the Big Buy Back a Big Sell Back with reverse effects. While filing for bankruptcy is the alternative that seems increasingly fashionable, see Tidewater, Carillion, Claire’s, Toys“R”Us, Avaya, RadioShack and so on. In all cases share prices will drop. How far they drop will depend on the way debts are resolved. So the question is: can a debt bubble of the present magnitude be endlessly pushed a little further into the future?

1. Federal Reserve Board Governor Lael Brainard declared recently that, “business leverage outside the financial sector has risen to levels that are high relative to historical trends. In the nonfinancial business sector, the debt-to-income ratio has increased to near the upper end of its historical distribution, and net leverage at speculative-grade firms is especially elevated. […] As we have seen in previous cycles, unexpected negative shocks to earnings in combination with increased interest rates could lead to rising levels of delinquencies among business borrowers and related stresses to some banks’ balance sheets.”

https://wolfstreet.com/2018/04/19/now-even-a-fed-dove-homes-in-on-the-everything-bubble/

Which is contradicted by this: Torsten Sløk, chief international economist at Deutsche Bank, said Tuesday that, “Stocks are too worried about 3% today. The earnings season is going really well and at the macro level corporate America has plenty of cash and hence little borrowing needs, so companies are not impacted much by higher long rates.”

https://finance.yahoo.com/news/stocks-getting-smoked-companies-cant-step-stop-182135222.html

Time will tell who is spreading fake news.