The World Hits Its Credit Limit, And The Debt Market Is Starting To Realize That

Tyler Durden's picture

One month ago, when looking at the dramatic change in the market landscape when the first cracks in the central planning facade became evident and it appeared that central banks are in the process of rapidly losing credibility, and the faith of an entire generation of traders whose only trading strategy is to "BTFD", we presented a critical report by Citigroup's Matt King, who asked "has the world reached its credit limit" summarized the two biggest financial issues facing the world at this stage.

The first is that even as central banks have continued pumping record amount of liquidity in the market, the market's response has been increasingly shaky (in no small part due to the surge in the dollar and the resulting Emerging Market debt crisis), and in the case of Junk bonds, a downright disaster. As King summarized it "models linking QE to markets seem to have broken down."

Needless to say this was bad news for everyone hoping that just a little more QE is all that is needed to return to all time S&P500 highs. And while this concern has faded somewhat in the past few weeks as the most violent short squeeze in history has lifted the market almost back to record highs even as Q3 earnings season is turning out just as bad, if not worse, as most had predicted, nothing has fundamentally changed and the fears over EM reserve drawdown will shortly re-emerge, once the punditry reads between the latest Chinese money creation and capital outflow lines.

The second, and far greater problem, facing the world is precisely what the Fed and its central bank peers have been fighting all along: too much global debt accumulating an ever faster pace, while global growth is stagnant and in fact declining.

King's take: "there has been plenty of credit, just not much growth."

Our take: we have - long ago - crossed the Rubicon where incremental debt results in incremental growth, and are currently in an unprecedented place where economic textbooks no longer work, and where incremental debt leads to a drop in global growth. Much more than ZIRP, NIRP, QE, or Helicopter money, this is the true singularity, because absent wholesale debt destruction - either through default or hyperinflation - the world is doomed to, first, a recession and then a depression the likes of which have never been seen. By buying assets and by keeping the VIX suppressed (for a phenomenal read on this topic we recommend Artemis Capital's "Volatility and the Allegory of the Prisoner’s Dilemma"), central banks are only delaying the inevitable.

The bottom line is clear: at the macro level, the world is now tapped out, and there are virtually no pockets for credit creation left at the consolidated level, between household, corporate, financial and government debt.

What about at the micro level, because while the world has clearly hit its debt-saturation point, corporations - at least the highly rated ones - seem to have no problems with accessing debt markets and raising capital, even if the biggest use of proceeds is stock buybacks, thereby creating a vicious, Munchausenesque close loop scheme, in which the rising stock prices courtesy of more debt, is giving debt investors the impression that the company is far healthier than it actually is precisely because it has more, not less, debt!

The reality, as we first showed in January of 2014, is that for all the talk of "fortress" balance sheets, and record cash buffers, the debt build up among US corporations has more than surpassed the increase in cash. In fact, as of early 2014, total debt was 35% higher than its prior peak, as was net debt.

 

Therefore, to us, the answer whether debt markets are once again approaching (or have crossed into) full capacity was clear; just look at what happened to IBM when, as we predicted, it bought back so much stock its investment grade rating was put in jeopardy and the company has seen its stock languish ever since unable to lever up any more just to repurchase its own stock.

Others, of the "more serious people" variety, have finally caught up, and as UBS' Matt Mish asks in a note late last week, "Releveraging: are debt markets approaching full capacity?"

His take:

In our latest strategy piece we concluded that, even in a stressed scenario, US and European high grade issuance could decline from peak levels yet overall activity should remain quite resilient. Well, that thesis could be tested in the coming months following a rash of (large) M&A announcements, including AB InBev's $106bn proposed acquisition of SABMiller, Dell's planned takeover of EMC, Sandisk's reported attempts to find a suitor and Analog Devices indicated to be in talks with Maxim. The phenomenon is straightforward, and one we have been touting for some time: firms are increasingly releveraging balance sheets as earnings languish. Wal-Mart is perhaps the latest example, issuing disappointing profit guidance as it seeks to spend significant sums on labor and the internet in an effort to reignite sales growth (and authorizing $20bn in share buybacks to boot).

It should be clear to most what this means, but since "most" haven't seen a rate hike in their Wall Street careers, here is UBS' summary "This is textbook later stages of the credit cycle."

* * *

Having seen the light, Mish asks why what is now so obvious to him, is so confusing to everyone else:

What we find interesting is that most issuers and equity investors do not consider the prospect that debt markets could be reaching a point of full capacity – at least not in the near term. There are two root causes of this belief, in our view. First, neither has a strong appreciation of the divergences between debt and equity market universes. First, equity investors typically focus on large cap benchmarks (e.g., S&P 500) – of which most of the market capitalization lies in the top 100 firms – and generally see strong balance sheets with low net leverage, many of which are rated single and double A. However, that is not what credit investors view in their own universe. By definition, while equity indices weighted by market capitalization have been biased towards higher quality companies which have low debt and high cash balances, debt indices weighted by debt outstanding have been skewed towards those issuers raising more debt and generally levering up (Figure 1).

 

 

In the US, this first occurred in US leveraged loans (and to a lesser extent high yield) – driven primarily by financially savvy private equity owners; now it is manifesting itself in high grade as strategics lever up balance sheets to juice earnings in an environment where hiking dividends (further), buying back (more) stock, and spending on capex (particularly overseas) appears to have diminishing marginal returns. Second, this cohort perceives low rates as a key stabilizer for financing costs. As we argued last week, low Treasury yields are a key source of support for high grade bond yields. In recent months, even as IG credit spreads have widened, government bond yield declines have helped soften the overall impact on funding costs. For high yield yields, however, the major component is credit spreads, so low Treasury yields can only do so much.

 

* * *

 

And releveraging and the underlying dynamics are not occurring in a US vacuum. In our opinion, European issuers and equity investors also do not fully appreciate the divergences in fundamentals between equity and debt markets. Our analysis shows median net leverage has been rising for European IG and HY companies for several years, while trends in median leverage for Eurostoxx 50 issuers have been more stable (until 2014, Figure 2).

 

Late last and earlier this year European credit investors are increasingly seeing US issuers selling Euro-denominated IG debt to fund M&A as well as viewing domestic issuers releveraging balance sheets (e.g., in technology, healthcare, consumer staples and telecom, Figure 3). And the general direction appears to be similar, whether we look at high grade or high yield (Figure 4).

 

For those who missed our preview of all of this from April 2012 "How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement", here is UBS' far simpler summary which even 17-year-old hedge fund managers should get:

Here lies the problem. The predestined outcome is essentially a standoff between equity and debt investors where the former will continue to pressure the latter until credit spreads widen enough to cause capital market access to contract, stemming the deal flow. In high yield, the likelihood of reaching a breaking point is greater – we have seen instances where this has already occurred and equity investors could be complacent in this respect. However, in high grade, we reiterate that the markets are somewhat bulletproof. But the stakes are rising with each record deal. Near term, credit investors in aggregate will likely continue to hold their noses and absorb the releveraging until it becomes very extreme, though extracting wider spreads in the process. Unlikely, yes, in the next quarter or two; however, even in high grade we cannot envision this type of punishment lasting for a couple more years.

And that is the real countdown, because while the Fed may or may not have any credibility left, the only thing that matters is what is left of the once proud "bond vigilantes", virtually all of whom have been euthanized by the Fed's steamrolling of every last fundamental tenet of the market held dear by the bond trades and analysts of the world. According to UBS this, too, is now coming to an end, and even in IG the relentless issuance of one record debt deal after another, will soon hit a brick wall. That, coupled with the peak debt at the macro level described on top, will be the catalyst for the next phase in the evolution of centrally-planned capital "markets", whatever it may be.

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15horses1donkey's picture

Entirely new currency = new debt market?

Zero Hedge Coin 0

kkvakk's picture

Credit appetite/growth stalled in 2007 already. That very thing IS the crisis. Now since 4th quarter 2014 also credit to Asia is contracting.....

two hoots's picture

How long does it take for the sky to fall? 

wizteknet's picture

What a hangover when I typed that... I can just laugh about it all the following day. FIAT debt!

ZH Snob's picture

time to pay up?  never, it would seem.

and all the debt recyclers will ride this out until the conductor demands payment.  that will be the point of failure where PMs will be the only acceptable currency.

that, in essence, is when the reset will occur.

wanderer9641's picture

How many people live in a LALA land where  the banks forget who owes them money - banks never forget.

janus's picture

what is this 'money' of which you speak?

i'll be more than happy to repay bits of paper 'privately' issued in kind...hell, i'll issue them an enormous bonus -- a one-trillion janus-note with my avatar featured prominently in its center for 'repayment' of 'money' that was never theirs to begin with.  

the law is a funny thing, my friend...far more fungible than 'money' itself.  this money-printing-business is a two-edged sword, and the paper-cut slices both ways.  

'banks never forget'...maybe, but all bankers die, and their memories with them.  

perhaps my favorite among Christ's poignant and powerful allegories was that of the rich man (banker)...it goes a lil something like this (from Luke's Gospel):

 And he told them this parable: "The ground of a certain rich man produced a good crop. He thought to himself, 'What shall I do? I have no place to store my crops.' "Then he said, 'This is what I'll do. I will tear down my barns and build bigger ones, and there I will store all my grain and my goods. And I'll say to myself, "You have plenty of good things laid up for many years. Take life easy; eat, drink and be merry."' "But God said to him, 'You fool! This very night your life will be demanded from you. Then who will get what you have prepared for yourself?' "This is how it will be with anyone who stores up things for himself but is not rich toward God."

where neither moth nor rust corrupt, janus

 

wanderer9641's picture

repayment in a new currency will be a bitch.

Squid-puppets a-go-go's picture

whatbproblem would that solve

if new currency still has $velocity=0, nothing is resolved, its just an epic failed attempt at a reset

there is no way out of this without some element of jubilee

15horses1donkey's picture

Don't debt repayments add to velocity?

ThirdWorldDude's picture

Debt repayments? Why would anyone want to do that when the cost of capital is equal or less than 0?

 

The greedy termites eventually take down the tree which they feed off of and in which they live. Nothing new under the sun...

janus's picture

15horses1donkey,

count janus in.

as for which among the three options you've outlined, i hope Tyler invites the debate on these pages.

here's to wishing you well in your enterprise; and for my part, i submit my endorsement to it.

and, with respect to horses, donkeys and the like, here's a janus dedication to bankers everywhere -- courtesy of 'a band of horses'.

https://www.youtube.com/watch?v=UPW8y6woTBI

at every occasion i'll be ready for their funeral,

janus

SILVERGEDDON's picture


15horses1donkey.  I think if you keep pimping this idea on Zero Hedge as a cryptocurrency, I am gonna have to track you down, and bitch slap you into the middle of next week for being a pimp ass bankster schill bitcoin wannabe rat bastard motherfucker.  IF ZERO HEDGE HAD A FUCKING CURRENCY OF IT'S OWN, IT WOULD BE MINTED IN INCORRUPTABLE NON HYPOTHECATED NON DERIVATIVE NON MARGIN ABLE SILVER OR GOLD. Get your shit together, and change your direction while you still have an ass to kick. Jesus, fucking kids these days. You all think technology is a miracle. All it is is electrons that can be made to go poof any fucking minute now. if i blew up your phone right now, you would look like a cow at the slaughterhouse just at the moment the bolt gun goes off - " How could you do this to me ? What'll I do now ? " Improvise. Adapt. Overcome. Triumph over adversity. And, transform your idea into minting  a fucking coin out of noble metals, or I will make you look like a one legged man at a nut kicking contest.  

Groundhog Day's picture

In a full faith and credit world, their are no limits

Winston Churchill's picture

That is about to be tested, and probably found to be sadly wrong.

JRobby's picture

Printing has a limit.

The slogans thrown around a short time ago:

"QE to infinity and beyond"

"Print until the economy obeys" etc. while humorous for a moment, did not recognize that it reaches a mathematical terminus.

wizteknet's picture

Like the guy said above Termite will eat its own house, even if it wont have one afterwards.

DaddyO's picture

C'mon Tyler, we know you're good in the ring, but you must have missed the proofreading class.

Fix the grammar in your headline...

DaddyO

edit: Thanks

tiger215's picture

Grammar hasn't cost us all a fortune. 6 and a half years of negative market guidance has. QE has sent the market phenomenally higher; and, if you followed the negative comments herein, staying out of the market.....well, as the surfers say, "man you really missed it".

Groundhog Day's picture

Ignorance would have been bliss, at least I would have felt rich before its all taken away

wizteknet's picture

Hell futures are all green, talk about hilarious...

Usurious's picture
Usurious (not verified) Oct 18, 2015 9:57 AM

 

 

trav7777

'The panics came because of repeated malfeasance by BANKERS, and the domination of this profession by one particular set of cousins is the reason the clan has been repeatedly run out of entire countries throughout history.  Bankers have been cheaters since day one, when they figured out they could con people with fractional reserve.

Fractional reserve lets bankers EARN INTEREST on capital they DO NOT EVEN POSSESS.  This is why banking is inequitable and a societal EVIL.  Bankers and banking should be banned as contrary to public policy.  Let banking become lend your REAL capital, fine.  But every single financial panic, bubble, collapse, all of it, is traceable directly to the feet of bankers who committed fraud.'

http://www.zerohedge.com/article/antal-fekete-why-gold-standard-must-be-rehabilitated#comment-629748

 

lolmao500's picture

This is gonna be fun :

Stunning if true: Algeria press says Russia considering Libya intervention, already conducting recon flights

Buckaroo Banzai's picture

It seems like there's a new sheriff in town.

Thanks, 0bama!

rejected's picture

Libya,,, another in a long string of  bell ringers for ussa's bomb'em into the stone age diplomacy. A complete failed state, nothing more than a large terrorist training camp. Russians are probably monitoring the flow of these u.s moderate terrorists to locate their bases of operation. If they follow them too long the Russians are going to end up in Langley Virginia's airspace.

rejected's picture

QE, ZIRP and NIRP along with the desire to go cashless are the obvious clues a fiat currency system always fails.

Money should have a standard just like units of measurements and not based on some bobblehead stooge PhD.

 

 

El Vaquero's picture

When money is lent, it should not be avaliable to the lender until it is payed back.  People think that they have a moral obligation to the banks.  They don't.  The banks don't offer you any consideration when they lend you money.  The people who made the goods you're buying with the bank's credit are who gave you the consideration.  The merchant who purchased some goods to sell to you is who gave you the consideration.  The fucking banks made an entry into an account ledger stating that you have X number of dollars and charged you interest on that.  Fractional reserve banking is a scam.  Take part in it if you have to get by, but don't feel bad about fucking the banks.  They brought it upon themselves by setting up a ponzi scheme where it is mathematically certain that it will collapse, and they did so so that they could fleece you and I. 

coast's picture

GLobal monetary reset not too far off now...any guesses when?  I say maybe as early as next spring?  Speaking of global reset, have you all really looked at the united nations flag?  I never really looked at it until last nite and its like wtf?  I cant make heads nor tales of it....Here is the link to the picture of flag, I would be interested in hearing any comments in regards....thanks...

To me it looks almost like crosshairs aiming at something someone just threw up..

https://upload.wikimedia.org/wikipedia/commons/2/2f/Flag_of_the_United_N...

 

Conax's picture

It represents the world overlaid with a 33 section grid (counting the north pole circle) to recall the 33 degrees of douchebaggery.

The garland thing around it symbolizes the headgear of the Emperor Tiberius, meaning they are potentates, 'we own your asses' is the message.

It's blue to inspire trust, faith and awesomeness.

Shoot on sight.

wizteknet's picture

So friggen funny! There are 193 United Nations (UN) member states.

JRobby's picture

Reset after population reduction is the schedule.

Exalt's picture

It's a top down view on the world i.e. we're up top, you're down there. Maybe we'll trickle something to you... Maybe... Trickle...

CHoward's picture

The ONLY limit is their imagination. 

Not My Real Name's picture

The ONLY limit is confidence. Fixed it.

LetsGetPhysical's picture

If the FED (and other Central Banks) can print money out of thin air how can there be a credit limit? QE4, QE5, QE6, .......QE256.....?????????

Exalt's picture

The credit limit is an illusion created to keep the sheeple happy. If we put a mark in the sand and say we can't cross it, but then do, we just put another mark in the sand until we cross that too. QE4EVA my friend...

Oilcrashing's picture

This is what is really happening:

What is purchasing power? It is the ability to gain capital, to wrest it from the Earth; to net it from the oceans, to pump it from wells, to harvest it from the soil. Food does not jump into our mouths or coal appear by magic inside our boilers. These things must be 'purchased', literally ... by way of 'work' (physics).

Capital is non-renewable resources or renewable varieties that are exploited to the degree that they become non-renewing.

Money is a claim -- a derivative one -- against purchasing power, so are ALL assets. These things are not purchasing power by themselves.

Purchasing power is at all times equal to available capital. As capital is depleted by way of industry and consumption, so is purchasing power. At the end of the day their is no capital available; there is no purchasing power, either. All claims against purchasing power including money and other assets are worthless.

Adding more claims by increasing 'fairness' or more demands against capital is self-defeating because purchasing power is not increased. Instead, capital and purchasing power are depleted more quickly. At the same time, the purchasing power lost is gone forever and cannot be reclaimed! ... any more than oil can be pumped back into the ground.

If Central Banks continue to print money, money will end up losing its value, money will end up becoming worthless. In this new era we are left with only two options: To conserve our capital voluntarily, or to conserve our capital by going the way of Syria, Lybia, Ukraine, Greece... It's up to us.

Source: http://www.economic-undertow.com/

SofaPapa's picture

Good comment.

The Wall Street system (or any "financial system" throughout history) is based on the faith that their activities foster the growth of real capital.  The concept is that by "lending", bankers are giving individuals or groups a period of time in which to create the real capital (as you describe it above), of which they keep some and the bankers take a cut to repay their "loan".  In a fiat system, it will always reach the same endpoint, which we are seeing today: the bankers - being convinced their activity initiates the creation of capital - "lend" more and more "money" (it is, after all unlimited in quantity.  That's what fiat means), desperately trying to force that "money" to turn into real things.  But because (as has been pointed out on zh thousands of times) the money retuned on a loan must equal more than the loan itself (the definition of interest), the system inherently can never catch up.  As stated by commenters above, the final limit on this cycle is the faith of the population in the concept the bankers started with.  As long as the population believes the initial premise - i.e. that banking leads to actual capital creation - the bankers are allowed to continue their game, and to take their free cut of real capital (free since the money has zero value at its inception).  Once the population realizes that the bankers are getting their cut, but net capital is actually being destroyed rather than created, the game ends.  That's getting closer every day, but we're not there yet.  Remarkable how long it takes, from here in the bleachers observing...

the grateful unemployed's picture

a centrally planned economy without a plan

yogibear's picture

"If Central Banks continue to print money, money will end up losing its value, money will end up becoming worthless."

That's their plan to reduce debt. 

Fed won't raise rates until the dollar keeps free-falling. The market will have to force them.

Cautiously Pessimistic's picture

Oh...if I could only awaken those around me that slumber.  Friends, neighbors, colleagues that don't have a clue of how we got here and what additional pain is coming.  Everyone will be made to care. 

"Some men you just can't reach..."

 

 

DontWorry's picture

Such hand wringing.  The amount of debt is only limited by the ability to pay.  With ZIRP, there is the ability to carry much more debt than before.  It really is different this time.

moneybots's picture

"Such hand wringing.  The amount of debt is only limited by the ability to pay.  With ZIRP, there is the ability to carry much more debt than before.  It really is different this time."

 

Math never changes.

ZIRP does allow borrowing more than a 2% rate does, but ZIRP is not forever.  Leverage reverses to de-leverage.

 

Karl Denninger: "The truth is that measured by interest rates and home prices the average household today has $500/mo less in funds to spend on a house (including tax breaks) than it had in 2006.  After ten years the funds available for such a purpose has gone down by over 25%."

 

silverer's picture

I attribute most of the rot we see to the misallocation of productive industries and workers into non-productive uses; the chief offender being, you guessed it: governments.  It wasn't the productive citizens of any country in past history that brought their countries to ruin:  It was the wealth that the governments squandered and wasted, and the debt they stacked up, making good money disappear down rabbit holes.  Mr. Piper is on his way.

GoldIsMoney's picture

Why does every generation have to learn that you can not get rich by debts alone? Why do we have the currency breakdowns on a regular basis. Why do they not want to learn? Why does anyone trusts states with their fiat-money? Why is everone crying for getting fed by "government". Government hardly ever has benefits but the mountains of believeer into state pile up to somewhat beyond 200 Mio murdered people. In the name of some "state" or some religion and the newest one will maybe get the most deadliers. The church of envionment, in which everytthin has it's place but men. And how do we kill ourselves? With giving up the last pieces of freedom. And still the end si clear, every credit expansion stops. Either it is stopped on purpose or it's stops just by itself with millions of death corpses laying around... Now tel me that's not maximal stupidity.

Ban KKiller's picture

 "at the macro level, the world is now tapped out, and there are virtually no pockets for credit creation left at the consolidated level, between household, corporate, financial and government debt."

 

Sounds like a job for "Stupendous Accounting Man"! He can invent a new term to mislead and disarm the sheeple. 

HenryHall's picture

Stock buy-backs are essentially the exact opposite of Rights Issues.

In Rights Issues the shareholders put up more cash and the company issues them more stock. Companies do this because they want to expand and see an investment opportunity (such as a new factory).

If you were to do a Rights Issue and then do a stock buy-back in the same amount you have effectively completed a circle and the net effect is zero.

The inescapable deduction then is that a company which seeks to do a stock buy-back is doing the opposite of expanding. That is to say they are contracting their operation, downsizing the company. And when lots of companies do stock buy-backs that is unshakable evidence that the company sees worldwide depression in its future.

Or more simply it is clear and convincing evidence that we are already in a depression and the smart money is placing bets that will pay off when the depression gets worse.

Yes, the world will gradually get worse for 99+% of people until there is wholesale worldwide default on money owed to large banks and especially central banks.

 

And the lesson is - you may be forced to use banks, but don't trust them and don't keep any more money in banks than you absolutely must. Because such money is at risk of loss and no financial consideration is paid to you in exchange for taking on this risk.  Government and banks can cancel "deposit insurance" without notice any time the choose to.

Goldy Locks's picture

Remember M.V = P.Q ?

Wonder what will happen when http://www.usdebtclock.org/ makes a big pop.