Investment Grade Credit Risk Vs. Buybacks

Investment grade credit spreads are a leading indicator for buybacks. Buybacks are correlated with the stock market.

A credit spread is the difference in yield between two bonds of similar maturity but different credit quality. For example, if the 10-year Treasury note is trading at a yield of 2% and a 10-year corporate bond is trading at a yield of 4%, the corporate bond is said to offer a 200-basis-point spread over the Treasury.

As credit spreads rise, it gets more and more difficult to finance buybacks (credit conditions are worsening). Yields on corporate bonds go up (which coincides with a credit spread rise), which means that debt issued by the company (to buy back its own shares) has a higher interest rate. The result is that there will be less buybacks. There is a lag of 3 months (we borrow and then we spend).

Investment Grade Credit Spread Vs Buybacks

As buybacks are correlated with a rise in the stock market, we can assume that higher credit spreads are a leading indicator for lower equity markets with a lag of about 3 months.

So you could have predicted black monday in August 2015 (red graph) by looking at the rising credit spreads (blue graph).

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U.S. Debt

It is interesting to monitor how the public and private debt curves are trending.

Since the crisis of 2008, total credit market debt as a % of GDP has been going down for the first time since history. Private debt was in a debt deleveraging mode (blue graph), while the Federal Reserve’s public debt was in a debt expansion mode (red graph).

If we look at the nominal value of debt, we can see that since 2014, total, private and public debt are all growing again, resuming exponential expansion.

Marc Faber: When China Implodes, This Might Be Bullish For Gold

A very important development is happening today in China.

One after another company in China is defaulting on its debt. Marc Faber quotes: “We have a gigantic credit bubble here in China.” Example: Zhejiang Xingrun Real Estate Co real estate developer defaults. Chinese bank defaults.

What this does to the yuan is obvious, the yuan is declining. If it manages to go above 6.2 USD/CNY, you can expect large problems as the China carry trade will halt and many people invested in Chinese structured products will be in the dumps.

Marc Faber confirms this in the next video. He expects Chinese GDP growth to slow 50% from 8% to 4%. You would think that when the yuan drops, Chinese can’t buy that much gold anymore, but Marc Faber has another view on this. The yuan could drop and as a result Chinese gold demand could actually go up due to people protecting themselves from inflation (and defaults) in China.

Total credit market debt Vs. Dow Jones

Total credit market debt growth is correlated with the Dow Jones. As everything in the economy requires loans, credit expansion drives the economy today.

Whenever this credit growth stops (blue line drops), the Dow Jones (red line) will go down with it. We have seen this in the 1987, 2000, 2008 crashes.

Monitor the blue line as it may be an important indicator.

Total Credit Market Debt

Since 2008 we have started a new era. We entered the period of deleveraging. For more than half a decade we had an exponential growth system in credit, but we have ended this period. I will show you by analyzing “Total Credit Market Debt”.

Total Credit Market Debt today, is at an astonishingly $55.3 trillion dollars.

Chart 1: Total Credit Market Debt Owed

And it is 350% of GDP.

Chart 2: Total Credit Market Debt as a Percentage of GDP

The total credit market debt = federal/state/local government debt + federal debt to trust funds + business debt + household debt + domestic financial sector debt.

This total credit market debt can be divided by federal debt and private debt.

1) Federal debt: $16.7 trillion.

Chart 3: Federal Debt: Total Public Debt

Federal debt is at 100% of GDP.

Chart 4: Federal Debt: Total Public Debt as a % of GDP

2) Private debt: $40 trillion.

Chart 5: Private Debt

Private debt is at 245% of GDP.

Chart 6: Private Debt as a percentage of GDP

As you can see, since 2008, the private sector has been deleveraging (Chart 6) and the Federal Reserve has been preventing this to happen (Chart 4).

But overall, the Federal Reserve hasn’t printed enough money to keep debt going up exponentially (Chart 1).

So what happens when debt doesn’t grow exponentially? You will get an economic collapse as Chris Martenson explains here.

To read the analysis: go here.

Public Sector Credit Expansion Vs. Private Sector Credit Contraction

In 2009, Marc Faber said these words at one of his famous seminars: 

“But for the fiscal stimulus to even have a small chance of succeeding at reviving economic activity it has to be larger than the private sector credit contraction.”

In today’s world we have 2 opposing forces, one is Ben Bernanke’s public sector credit expansion (Chart 1) and the other is private sector credit contraction (Chart 2). If credit grows, all is well, but when they cancel each other out and credit contracts, a recession will start. To make it easy I took the credit growth chart for the money creation of banks (Chart 1). For the private sector I took the household debt chart (Chart 2).

Bank credit is going up due to money printing:

Chart 1: Bank Credit

Private sector debt is declining due to repayment of debt. I indicated that the savings rate has gone up to 6% now, so I expect more repayments in the future.

Chart 2: Private Sector Credit

If we then add these two charts together we get Chart 3 and the picture isn’t pretty. The percentage change in credit has gone negative and is at a historic low. As you can see, each recession (grey bar) is accompanied by a dropping credit and 2008 is by far the worst one. If we don’t see a rising trend here, you can expect ugly times ahead.

Chart 3: Credit Expansion/Contraction