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2022-09-16 07:00 by Karl Denninger
in Market Musings , 2298 references Ignore this thread
The Simple Facts On Equities And Debt
[Comments enabled]

No, the market is nowhere near a "buying point" or "bottom."

In fact its probably overpriced at 50% of today's prices -- even with the dump so far.

Here's why.

Have a look at that chart.

Corporations basically never pay off debt; they always roll it over.  Since 1980, roughly, the cost of money has always been cheaper, so every time that bond comes due and has to be rolled over the amount of money you must pay in interest on the new one is less.

This in turn means the amount the corporation pays in interest goes down and that means "E", or earnings, go up.

But -- this cycle presumes that rates will never rise.  That is, at worst the downward movement will cease, but never go the other way.


Because if it does (and it is and has for the last six months or so) then every time your bond comes due now you need to pay more in interest on the new one that replaces the old and that makes "E" go down.

"E" is simply what's left of what you take in after you pay expenses, of course, and if you have debt outstanding interest is one of your expenses.

People say The Fed "can't" raise rates.  Well, they are.  And worse, the TNX, 10 year Treasury, broke range and is likely headed to about 5% which means a "AAA" corporate bond should carry a coupon of somewhere between 5.5-6% because no matter how good that credit may be it is inferior to the US Treasury.

When the best credits out there roll over the next time, which they all will within the next couple to ten years, they will pay that 6% where they were paying 2 or 3%!  The only other option is to redeem the bond entirely which means forking up the face value in cash.

Take a firm that is regard as very well-managed -- Berkshire.  They have $119 billion in debt outstanding, and are certainly a AAA credit.  Let's assume that $119 billion currently carries a 2% coupon, so $2.38 billion in interest expense a year.  The firm's net income is $11.7 billion so what happens if the cost of carrying that debt doubles (say much less triples.)

That's a 20% whack off the earnings; if the cost triples its a massive 40%.

How does the "current" 58 P/E sound to you or even the so-called "forward projection" (commonly called a guess) if the earnings crash by nearly half?

Yeah, that's what I thought.

Oh, and this ignores input costs, which of course you can't.

As another example look at FedEx which reported last night.  Revenues largely met expectations but EPS missed by a third.  Where'd that come from?  Costs, obviously.  And, I might add, roll costs, that is, the spike higher in interest expense on outstanding debt are not yet showing up in any material size -- but they most-certainly will over coming quarters and years; it is unavoidable for anyone with outstanding paper.

PS: Given the quality of Berkshire's management and operational expertise what you're going to find in most other firms is worse -- and not a little worse either.  Buckle up.

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Comments on The Simple Facts On Equities And Debt
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Takewhatyoucan64 26 posts, incept 2022-08-30
2022-09-16 07:05:13

and FEDEX was down 20 percent this morning.........I wonder what there debt load is
Tickerguy 188k posts, incept 2007-06-26
2022-09-16 07:06:42

Trailing P/E is 15, operating margin 6.4%, net income $3.82b, $37 billion in debt.

If that is currently at 3% and goes to 6% that cuts net income by about a third.


NASA faked out a computer instead of running the test.
Then tried to launch and aborted instead of going "BOOOM!"
Did they abort the JABS after faking THOSE tests?
Jazen 4k posts, incept 2007-07-17
2022-09-16 07:11:55

2 year is getting close to 4%
And has been inverted with the 10 year for quite some time.
Buckle up indeed.
Yes, Berkshire's bond is rated AAA. What about companies who don't have such a good credit rating.
So many bad things are coming....a giant flush is on the horizon.

I hate our Government, but I still love America.
Tickerguy 188k posts, incept 2007-06-26
2022-09-16 07:13:07

@Jazen - AAA credit SHOULD trade around 100 bips over Treasuries of equivalent duration. Single-A should be trading 200-300 bips over. Bottom of investment grade should be trading around +300-400, beyond that Call Saul because the default risk is a wide-open gamble.

NASA faked out a computer instead of running the test.
Then tried to launch and aborted instead of going "BOOOM!"
Did they abort the JABS after faking THOSE tests?
Prof_dilligaf 398 posts, incept 2021-09-02
2022-09-16 07:27:48

We've all been sailin' along on a sea of cheap energy and even cheaper credit, and that ocean has started drying up, "unexpectedly" and everywhere. This winter is gonna be sumthin' alright, and there's no chance it's a good sumthin', even in a schadenfreude way, because no matter how thoroughly and meticulously you plan, you can never truly account for other people's stupidity and panic.

But on the lighter side:
Jazen 4k posts, incept 2007-07-17
2022-09-16 07:27:58

And then, once the debt bite sinks in and corporations lose money due to payments that have to be made, their credit ratings drop, which will incur a higher interest rate,'s a vicious downward spiral that is long overdue.

This may just be the necessary chokehold needed to be put on facist corporate America. No more stock buybacks....

I hate our Government, but I still love America.
Blanca 469 posts, incept 2020-07-25
2022-09-16 07:28:11

Karl - you were one of the few who got these rate increases right. And you are telling us the FED isn't through. You are also telling us the market is overvalued by 50%. I'm staying out of stocks!

What's interesting is how well the dollar is doing. The yen was nearly 100 to the dollar a couple of years ago. Now it's approaching 150 to the dollar.

The economic storm is here. It's looking like a hurricane!
Quantum 579 posts, incept 2021-05-18
2022-09-16 07:32:36

@Tickerguy Where do you expect real rates for Treasuries to settle? The norm pre-1999 was around 2% or so, but since then (and still now) they have generally been negative.

Then corporate debt will be another 2%+ on top of that.

Our God, will you not judge them? For we have no power to face this great multitude that is attacking us. We do not know what to do, but our eyes are on you. --2 Chron. 20:12
Tickerguy 188k posts, incept 2007-06-26
2022-09-16 07:32:24

In 2007 a fairly basic mathematical model said we should have seen the /DX go to 40 from about 80, which is where it was. It didn't. WHEN it didn't I had to re-examine a number of things, because obviously I was wrong about that, and figure out WHY I was wrong.

That's what led me to the reality of international trade sequestration. It fit EXACTLY and then tracked for the next 10 years, which is pretty damn good. But both Congress AND BUSINESS believed this would continue forever, and worse, that there would never be higher rates as a result.

That's fucking stupid; nothing, and I do mean nothing, ever goes on forever. EVENTUALLY there is a shift and its one thing to exploit a trend for a while when its in your favor, but if you do it at the expense of getting fucked when it reverses, boy YOU ARE STUPID and you deserve what you're going to up your chute when it does.

NASA faked out a computer instead of running the test.
Then tried to launch and aborted instead of going "BOOOM!"
Did they abort the JABS after faking THOSE tests?
Spanky 183 posts, incept 2011-03-22
2022-09-16 08:12:57

The Fred chart of debt didn't dump considerably in 1981 when the 10-year hit 15.5%. I realize there is a lot more debt and fragility in the system. How do you reconcile these two scenarios?
Takewhatyoucan64 26 posts, incept 2022-08-30
2022-09-16 08:13:08

Its gonna be more like a Tsunami
Flappingeagle 4k posts, incept 2011-04-14
2022-09-16 08:13:16

Great Ticker.
Corporations basically never pay off debt; they always roll it over.
Let me see if I can get this right. Corporations do not pay off debt because they want to use financial leverage to increase earnings. So, debt is not retired.

In a falling-interest-rate environment that means say XXX amount of debt is appropriate. But, in a rising-interest-rate environment that means say X amount of debt is appropriate. So, the company needs to retire XX to get to where it needs to be when the environments switch.

If the company is retiring XX, then it is not spending on something else. That something else is probably taken from a long list of cost-cutting measures such as capital expenditures, maintenance (lol), salary freezes (ouch),...

Honestly, I would not be surprised at a 50% drop from here to the bottom.


Here are my predictions for everyone to see:
S&P 500 at 320, DOW at 2200, Gold $300/oz, and Corn $2/bu.
No sign that housing, equities, or farmland are in a bubble- Yellen 11/14/13
Trying to leave
Windellmc 105 posts, incept 2012-02-26
2022-09-16 08:30:05

So the companies that borrowed to buy back stocks will need to reverse that to retire that debt?
Tickerguy 188k posts, incept 2007-06-26
2022-09-16 08:30:38

@Windellmc - If they can issue into that environment without collapsing the company, yep. It gets ugly if the new issue goes "no bid", and it might.

NASA faked out a computer instead of running the test.
Then tried to launch and aborted instead of going "BOOOM!"
Did they abort the JABS after faking THOSE tests?
Eoinw 128 posts, incept 2021-07-14
2022-09-16 08:41:13

I try to point out to people that even the largest corporations are loaded with debt. I don't actually know this but for me it's common sense. If practically every person in society wants to take on debt then all the businesses - run by similar people - will also grab all the credit they can get.

Thus, in my grocery store, the only money which stays in the community is employee salaries. Everything else is gone but not to some big vault at head office. It's really gone, to upper management and investors.

When my store did major renovations, they didn't go to the big vault in Montreal and take out a million dollars to pay for it. Instead they got a line of credit. Took on more debt to pay for the work.

If I'm understanding this correctly then all these corporations really are nothing more than giant parasites. If I'm incorrect, I'll appreciate other posters correcting me.
Cmoledor 1k posts, incept 2021-04-13
2022-09-16 08:50:11

Damn I appreciate your teaching style. Simple and easy to grasp. Cheers!

The whole world is one big fucking scam
Why are you giving a vulgarity warning here? Our genial host is an advocate of both skullfucking and sodomy via rusty chainsaw. Credit to Rollformer
Eoinw 128 posts, incept 2021-07-14
2022-09-16 08:56:57

In my simple way of thinking, one impression I've had in recent years is that the stock market is so manipulated that it won't crash unless those in control want it to crash. Naturally this is based on my not understanding the inner workings of the market.

If 2 1/2 years of covid have taught us anything it is that rule of law no longer exists in the West. Those in authority ignore basic rules and make up whatever rules they like. Is it possible for them to suspend "supply and demand" permanently by simply rigging everything? I'm pretty sure reality has the final say.

Are rising rates all that it will take to inject reality, as in a 50% value drop?

Could the Fed, by cutting rates at the first sign of crisis, manipulate the market so there isn't a big crash?

Also wondering if TG, or anyone else, has any idea of the timing for when this really shatters.
Djsnola 286 posts, incept 2009-03-16
2022-09-16 09:14:04

Karl it seems a good inflection point where the trade sequestration stopped was the ukraine war.. specifically the west targeting of Russian assets even people who were just russian citizens.. they popped this themselves with our arrogance and now the inflationary pressures of printing cant be sequestered overseas anymore... it was never going to last forever but it seems we did this to ourselves. Sad!
Tickerguy 188k posts, incept 2007-06-26
2022-09-16 09:14:32

Correct @Djsnola, but it always takes a good kick in the nuts, and sometimes two or more, to break a Pavlovian response.

NASA faked out a computer instead of running the test.
Then tried to launch and aborted instead of going "BOOOM!"
Did they abort the JABS after faking THOSE tests?
Notleftjeff 16 posts, incept 2021-04-25
2022-09-16 09:14:56

Eoinw, they can only manipulate it so much until real panic sets in and I assume that they would not hesitate to bail and get what they think is theirs. Good luck with that when everyone is heading for the exits at the same time.
Quik49 13k posts, incept 2007-12-11
2022-09-16 09:31:26

"Corporations basically never pay off debt; they always roll it over."

Neither do city's, county's, school districts, library's, municipal utility entities....ect ect ect

Winter is coming early

2 + 2 =5
Kennington 308 posts, incept 2013-09-12
2022-09-16 09:31:33

Karl, excellent analysis on the corporate debt side of the coin! A potentially more explosive element, perhaps you should write a book on it (Leverage ha ha), is what's happening with governmental debt.

In particular, I'm interested on your comments as to what this rise in interests rates is doing to the pricing of the Fed's balance sheet? Gotta be getting killed right?
Oliver1655 350 posts, incept 2012-08-02
2022-09-16 09:31:40

Hmmm, looks like the "crank of leverage" is about to go brrrrrrrrrrrrrrrrrrrrrrrrrrr in reverse.

Expect lots of wailing and gnashing of teeth that "nobody could have seen this coming".

Boredfree 660 posts, incept 2021-09-15
2022-09-16 09:31:53

My wife and I were discussing debt recently. When we took our loan to buy our property FIL tells us to get as much money as the bank would loan us due to the low interest rates. His logic was use the bank's money so if you had a financial hiccup, it was the bank's money we'd lose.

Kinda backwards thinking to the both of us, but makes sense if we were just going to flip our home.

Since we built a tomb rather than an asset (we hope to die of old age here) the less it cost the better off we are.

Debt isnt wealth. Not necessarily even if you are holding the paper. Stuff is worth what someone will pay for it. Look at all the debt companies had to eat 2006-2008.

Hasn't part of the recent housing boom been due to people buying 2nd, 3rd or 4th homes to rent out? Air b&B's are the recent fad driving these purchases and what happens when nobody can afford to travel?

How many mortgage payments can these small time Trumps make if they aren't renting? What happens when everyone get behind at the same time?

2006-2008? But even worse because the Fed blew their wad 14 years ago?

Pass the popcorn...

The problem is most people want to point a finger rather than their thumb when dealing with challenges.
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