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July 20, 2018  
Connecting the dots

There's nothing quite like the sound of a starter's pistol to let you know a race has begun. Sounds and flashes are all around us to warn, tell, and otherwise, make us aware that something is about to change. It would be so nice if we had some kind of loud and obvious signal to tell us that the economy has rolled over and that a recession is imminent.
What got me thinking about this? In the next few weeks, you're going to see a lot of articles about the collapse of Lehman Brothers, the storied investment bank that became the biggest corporate bankruptcy in history. You see, the 10 year anniversary of its hasty demise is this upcoming September 15 th. The collapse of Lehman was just one part, a major one at that, of the grand combination of haywire situations that we call the Great Recession. Bulwark stocks like Fannie Mae, Washington Mutual, AIG, Wachovia, Merrill Lynch and others, were obliterated.
But there were warnings that both the economy and the stock market were about to take a turn for the worse. Data about sub-prime loans were flashing yellow. Credit was becoming tighter. The Federal Reserve was raising rates. Bear Stearns failed 6 months before Lehman. And 12 years ago this month, two little-known Bear Stearns hedge funds that invested in sub-prime debt, collapsed. Investors lost all their money. It seems obvious today, but connecting these and so many other data points of that era wasn't so easy to do.
Today, the Great Recession seems like another lifetime ago. The banking sector is arguably in the best financial shape it has ever been in and U.S. GDP came in today above 4%. Things for the economy are pretty good these days. The major stock market averages are barely below all-time highs. Now, I'd like to shake you out of this nice little trance and put forth a few dots to connect.
Home sales are slowing down in San Francisco and Southern California. The yield curve is getting pancaked. Loan rates are rising. Loan volume is falling. Corporate debt is at a new all-time high. The Federal Reserve is raising rates. Stocks like Intel, Netflix, and Facebook are seeing their growth slow. GE, Ford and General Motors have been perpetual value traps. The dividend yield of the  S&P 500 is now lower than the yield of the 10 year Treasury bond.
Have these data points risen past the point of just being a bunch of isolated events or is there a common connection here? Are tariffs and politics just a sideshow; a distraction from the economic data points that really count toward asset valuation? How many data points could a pundit ignore until they finally say "I changed my mind, things are getting worse"?
Then again, the economy is strong and a quick resolution to international trade disputes could send the stocks averages to new highs. Stock buybacks are a Trillion Dollar force this year, despite the fact that American corporations are replacing their equity with debt. I borrowed the chart below from Jesse Columbo of "Real Investment Advice" in Houston, TX, and my former fellow Long Islander:
 "Ultra-low interest rates have encouraged corporations to borrow very heavily (via the bond market) since the Global Financial Crisis. Total outstanding non-financial U.S. corporate debt is up by over $2.5 trillion or 40 percent since its 2008 peak, causing the U.S. corporate debt-to-GDP ratio to hit an all-time high of over 45 percent, which is even more extreme than the level reached during the Dot-com bubble and U.S. housing and credit bubble" 
You can click on the chart to see his recent post with over 20 other charts that should scare the daylights out of any investor who will be needing to tap into their investment funds within the next few years and probably even longer than that.
You can infer from the chart that when the bull market and economic cycles turn, companies rush to turn their debt back into equity, which has ALWAYS happened at lower valuations. Why? Because companies have a more difficult time borrowing during recessions, so when they're desperate for cash, they give their stock away for whatever cash they can get for it.
So, what's the purpose of my Friday post this week? To let you know that beneath the surface of a 4% GDP print, the lines that connect the above dots are forming. Be careful out there. 

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