$195 Billion Asset Manager: "The Time Has Come To Leave The Dance Floor"

Tyler Durden's picture

We find it surprising how, having covered the unprecedented growth in US corporate debt over the past few years, which has more than doubled from $2 trillion at around the time of the financial crisis to approximately $6 trillion currently...

 

... resulting in a debt/ETBIDA ratio that has never been higher...

... some are still amazed by what is taking place on corporate America's balance sheets.

Overnight, one person warning how all this will end is TCW Group's Tad Rivelle, who is the latest to observe that "corporate leverage, which has exceeded levels reached before the 2008 financial crisis, is a sign that investors should start preparing for the end of the credit cycle."

Rivelle says that “the credit-fuelled expansion inevitably comes to a bad end,” Rivelle, chief investment officer for fixed income at TCW, said in a note sent to investors Tuesday. “We’ve lived this story before.”

He is, of course, right: corporate leverage in America continues to soar to new highs every month, and just in September sales of company bonds passed $1 trillion for the fifth consecutive year according to Bloomberg. Total company debt is at a record 2.4 times collective earnings as of June, according to a Sept. 9 estimate from Morgan Stanley. The ratio fell to 1.7 in 2010 when the U.S. economy started recovering from the Great Recession.

Rivelle, whose firm oversees $195 billion, blames central bankers for fueling asset bubbles, which are bound to collapse as leverage goes up faster than income available to service debt. “Our counsel remains as it has been: avoid those assets that will be broken in the coming de-leveraging while keeping a ‘steady as she goes’ attitude towards the future purchase of those assets that will merely bend when the flood come,” Rivelle wrote.

His other observations are just as dire in their stark admission of just how scary reality has become:

over the course of the past 25 years, the traditional business cycle has been replaced with an asset price cycle. Rather than let recessions run their painful but necessary course, central bankers move forthwith to dispense the monetary morphine. The Fed’s playbook on this is well worn: first, policy rates are lowered. This triggers a daisy-chain of events: low or zero rates promote a reach for yield; the reach for yield lowers capitalization rates across a variety of asset classes which, in turn, spurs a rise in asset prices. Rising asset prices – the so-called wealth effect – “rescues” the economy by rebuilding balance sheets and restoring the animal spirits. And voila! Aggregate demand rises, businesses invest, and a virtuous growth process is launched.

 

Well, maybe not so much. If it were all so simple, then why is it that after ninety something months of zero or near zero rates, growth is sputtering, the corporate sector is in an earnings recession, and productivity growth is negative?

 

The explanation is simple: growth is not a simple function of higher asset prices.

Which, incidentally means, that central bankers are now powerless.

Rivelle concludes with an even more dire warning:"Face it: the central banking Emperors have no clothes... when the supposed solutions to the Fed’s dilemma are merely new “problems,” you know you are approaching the cycle’s end... successful, long-term investing is predicated on not just knowing where the happening parties are during the reflationary parts of the cycle but, even more importantly, knowing when the time has come to leave the dance floor. In our view, that time has already come."

* * *

Here is his full note:

Trading Secrets: Twilight of the Central Bankers

While every asset price cycle is different, they all end the same way: in tears. As obvious as this truth is to investors, when the sad end to the credit cycle comes, it always comes as a big surprise to many, including the central bankers who, reliant on their models, confidently tell you that no recession is (ever) in the forecast. But, successful, long-term investing is predicated on not just knowing where the happening parties are during the reflationary parts of the cycle but, even more importantly, knowing when the time has come to leave the dance floor. In our view, that time has already come.

Allow us to properly explain ourselves. Consider the chart below which plots the trajectory of cumulative asset prices (stocks, bonds, real-estate) against that of aggregate income (GDP):

The chart reveals something rather extraordinary: over the course of the past 25 years, the traditional business cycle has been replaced with an asset price cycle. Rather than let recessions run their painful but necessary course, central bankers move forthwith to dispense the monetary morphine. The Fed’s playbook on this is well worn: first, policy rates are lowered. This triggers a daisy-chain of events: low or zero rates promote a reach for yield; the reach for yield lowers capitalization rates across a variety of asset classes which, in turn, spurs a rise in asset prices. Rising asset prices – the so-called wealth effect – “rescues” the economy by rebuilding balance sheets and restoring the animal spirits. And voila! Aggregate demand rises, businesses invest, and a virtuous growth process is launched.

Well, maybe not so much. If it were all so simple, then why is it that after ninety something months of zero or near zero rates, growth is sputtering, the corporate sector is in an earnings recession, and productivity growth is negative?

The explanation is simple: growth is not a simple function of higher asset prices. Growth results when the productive sectors of the economy make themselves more productive by delivering goods more efficiently or by innovating products valued by the marketplace. In short, the vast partnership of labor and capital that is our economy must constantly up its game so as to expand output and, along with it, incomes. The process by which this happens is essentially Schumpeterian: profitable activities expand and bid resources away from the decaying and inefficient. Say what one wants, this has been the wealth engine for centuries. 

The central banker’s model of growth not only ignores these creative/destructive forces – it is antithetical to them. Consider: what does a boom in asset prices actually foster? Higher asset prices literally means that your economy has “more” assets. If you double the value of all homes in the nation, then you have “twice” as much real-estate. But twice the real-estate means there is twice the real-estate to lend against. Effectively, higher asset prices is the Fed’s mechanism for expanding the system-wide pool of loanable collateral. More collateral means that more credit can be created. Of course, in the short-run, more credit creation feels like an economic recovery, which is why monetary expediency has so many cheerleaders.

But buying growth today with credit that needs to be repaid tomorrow is not a free lunch! Artificially “stimulated” credit creation means marginal or even unprofitable enterprises are being fed when they should actually be starved. Further, the low rate induced asset price inflation preferentially directs credit to those who are already asset rich. Those whose assets have inflated now possess more collateral, making them more credit-worthy in the eyes of the lender. This results in all sorts of distortions that serve to further impair efficiency. Fortune 500 companies get to borrow cheap so as to repurchase shares even as small businesses are starved for capital; affluent homeowners get favorable access to loans to build swimming pools while renters suffer impoverishment by the resulting housing price inflation.

Indeed, the longer term consequences of policies that fixate on credit growth lead to a general, system-wide expansion of leverage ratios. Meanwhile, this credit inflation disempowers the market based mechanisms that would otherwise allocate resources to their highest, best uses. The result? Leverage goes up faster than the income available to service it. As such, the credit-fuelled expansion inevitably comes to a bad end. We’ve lived this story before: indeed, while every cycle is distinctly different, they all end up suffering from the same central banker induced maladies. Consider the similarities in terms of where we are today versus where we were in 2007:

It’s back to the future – again. Leverage has returned, most notably in the corporate sector where debt metrics have not just roundtripped but indeed are now in excess of the levels experienced before the Great Recession.

And while the Fed clings to the fiction that it is “data dependent,” its response function – cowering in the face of every market “tantrum” – reveals monetary policy to be what it really is: a put on financial prices. But can the Fed, Canute-like, hold back the future tides of de-leveraging? No, though we expect that they, like their comrades in arms at the ECB and BOJ, will keep trying. Indeed, negative rates can be best understood as merely the latest attempt to forestall the failures of policies past. But, is anyone helped by establishing negative “hurdle” rates to incentivize “investment?” If a commitment of capital requires a negative opportunity cost, then whatever activity that might be launched will assuredly be productivity destroying. Negative rates have all the economic “logic” of destroying the village so as to rebuild it. It is monetary madness and while it might hold back the flood for a time, it fairly well guarantees that when the flood comes, it will be worse than it would otherwise.

Face it: the central banking Emperors have no clothes. But, might the Fed come up with new artifices to prop up the towers of leverage they have built? They might, though it would be folly. Yet, underestimating folly is, I suppose, a folly of its own. The Fed could continue to use its printing press to falsify capital market signals, but to what end? When a central bank buys an asset with an electronically printed dollar, a “something for nothing” trade has taken place. Unless everything we understand about economics is plain wrong, the Fed cannot go on blithely adding printing press dollars to the system and expect no ill effects. Essentially, inflationist monetary policies cannot be the answer to the problems caused by inflationist monetary policy.

And this is precisely our point: when the supposed “solutions” to the Fed’s dilemma are merely new “problems,” you know you are approaching the cycle’s end. Our counsel remains as it has been: avoid those assets that will be broken in the coming de-leveraging while keeping a “steady as she goes” attitude towards the future purchase of those assets that will merely bend when the flood comes.

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roxyNL's picture

the party is over bitchez

the globalist rats will soon jump over sinking america

captain trump will bear the blame

 

svayambhu108's picture

Post 2008 is all rigged you shouldn't be on the dance floor anyway unless you are amogn the ones that rigged it.
I mean it was rigged before but now is totally rigged.

 

Remember those lasers, behind them are hard working robots trading your pension money. 

 

Rainman's picture

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”

 ~ Chuckie Prince , Citigroup, 2007

MillionDollarBonus_'s picture

Corporate debt may have risen, but companies can afford it. Look at the record valuations of S&P 500 corporations - why not use these high stock prices as collateral to borrow even more? Interest rates are at record lows - this is a phenomenal opportunity for corporations to invest and expand. And the timing is perfect too. What better time to invest in your company than during the first phase of an economic recovery? Companies that take advantage of this opportunity and borrow aggressively are going to dominate as America's economy takes off.

WHY COMMON CORE IS ESSENTIAL FOR EDUCATIONAL PROGRESS

Life of Illusion's picture

 

 

MARKETS OF ILLUSIONS WITH FED AT THE WHEEL

svayambhu108's picture

@Rainman> “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,”

 ~ Chuckie Prince , Citigroup, 2007

After 2008 we dance on some 8-bit psytrance made by robots.

PAPA ROACH's picture

Does this mean there will be even moar cash on the sidelines?

Lonesome Crow's picture

 

 

 

Yes!

Cycle ends when the Main Event is RE-PORTED.

As of now it is still being PORTED.

oops's picture

KARMA for the Greatest Injustice of the 20th Century.
http://wp.me/p4OZ4v-19

JamesBond's picture

It's best to remember that in the US, its everyone for themselves now.  No law, no order, no consequences.  

 

jb

r0mulus's picture

You mean we dance to 'Algo-Rhythms'? ; D

OverTheHedge's picture

So these guys are going to pull $200 billion from the market? In the real world, that might suggest asset prices could slide a little bit.

Probably buy the dip?

JRobby's picture

Such valuations! It is a certainty that cash flows will continue to rise and that debt can be paid off without a problem! Or, just issue more stawks to pay it off.

It's so easy these days, even common core educated dolts can do it!

Million Dollar Bonehead's picture

It is shameful that a serf should be allowed to accumulate wealth. The servant class would be more content if they merely accepted their position in society and allowed Dear Leader Hillary to control the wealth for them. Pain and humiliation await all who do not submit to Dear Leader's will. May the All powerful Sword Of Dagon smite the rebellious as Dear Leader laughs with derision.

greenskeeper carl's picture

Funny about that debt. I thought about that when the guy in the article mentioned businesses 'borrowing to invest in their companies' or some such nonsense. Companies haven't been investing in expansion. They've been borrowing money to fund stock buy backs to boost share prices so those running the show get bigger bonuses. Now they are sitting on piles of debt that they can't pay back with expansion because they can't expand due to the fact that they squandered the possibility for long term growth on short term stock gains.

Escrava Isaura's picture

Wait a minute.

I was told by Zero Hedge that “On a long enough timeline, the survival rate drops to zero” so why care about the long term if it’s not gonna be there.

 

eatthebanksters's picture

Valuations are up because of cheap money from the Fed...watch what happens to those valuations as the Fed starts raising rates.

Yen Cross's picture

  MDB ~the discredited hack~ hath spoken.

 How much do you get paid for the downvotes?

freewolf7's picture

Tyler provides data, and MDB provokes emotion. They work in tandem.

svayambhu108's picture

The daily 500 millisecond of hate till you press the downvote button

trutalk's picture

Good one MDB!  You are in rare form today. Seems like most here don't get the joke. I think it is hilarious and brilliant. Keep 'em coming. 

Yen Cross's picture

  Everone enjoys a good ribbing[joke] but MDB is just a distraction.

adanata's picture

 

Stop looking, then you won't be distracted. It's easy... I do it every time MDB posts; just cruise on by and ignore any references.

Likely it will get bored and move away.

E.Shackle.Ton's picture

It would be good if they turned that money around and did invest it in capital producing projects; but they don't.  It appears that the money is used for stock buy backs, increasing your aforementioned valuations.  Good for the CEO's who are compensated on stock price performance.  Bad for the companies they run.  There is no capital to provide more competitive goods and services.  Therefore, there is little to no income to repay these bonds (even if they are almost free money).  I would readily conclude, that these are not HG bonds but in the terms of the "Big Short", they are dog shit.

OldBoy's picture

Add this to your common core and maybe the world will start to change for the better

https://jackkornfield.com/meditation-lovingkindness/

allgoodmen's picture

Re: MDB and My Sister accounts

Tyler should implement a simple algorithm. When downvotes exceed a 5:1 ratio (>100 votes total) autoban the account

stocker84's picture

It has become apparently obvious that MillionDollarBonus_ is a shill and he/she/it is just trying to get a rise out of anyone who will listen.

 

I fell for it a couple of times, but it's clear that the purpose is to disseminate a doctrine that is failed all over the world throughout history.

 

Don't fall for it. The discourse appears to be intended to just poke sticks at anybody who replies.

 

Only an idiot thinks this is sustainable. 

 

Look at comments about him/her/it regarding his ridiculous website that he shamelessly promotes.

https://accredited-times.com/about/

 

hxc's picture

Accredited Times is obviously satire. Even the title

eekastar's picture

Sorry pal, there is no investment by corporations other than turning QE into (short term) profit.

Neither consumers nor corporations have any confidence in (the market of) the real economy.

So off they go with the "Easy Money" and into financial markets they went: buyback & takeovers = bonusses.

 

 

ljag's picture

Do I get points for exposing the one word MDB couldn't get around? No, ok, I tell you anyway: EXPAND. Expand what....the number of shares being bought? Haha!

ebworthen's picture

Priceless sarcasm there MillionDollarBonus, absolutely priceless.

nibiru's picture

Next thing on the news - IMF trying to emancipate as the World Government 

 

Keep stacking or be ready to get your asses served

The Saint's picture

Central bankers still have lots of power.  All Yellen has to do is crank up fed funds a couple times and everything will come crashing down.  And she seems to be thinking about doing just that.  I hope it starts today.  It would be the final nail in the Clinton/Obama coffin.

 

JRobby's picture

She thinks! Now there is a news item!

Hohum's picture

Over?  Janet Yellen says when it's over.

SomethingSomethingDarkSide's picture

These are Simon Says Markets and YELLEN HASN'T SAID YET SO STFU & BTFD

SixIsNinE's picture

yes, and according to the graph with the two previous bubbles being the dot com and housing,  well this is THE Central Bankster Bubble, and if they know anything, it's about blowing bubbles.   That means this bubble is just getting started.  Much Much Moar elasticity in this bubble with several more upward heads & shoulders thrown upon us ....

maybe it's the successor to ol' Yellen that will have to deal with the Popping& sharting

 

Yen Cross's picture

  You need to up your meds.  When things get nasty they'll blame Bush.

Silver Bug's picture

The smart money is getting out of this paper ponzi scheme. The smarter money is moving that money into gold and silver. Get ready for a bumpy ride.

 

http://jimrickards.blogspot.com/2016/09/reveals-imf-world-currency-crash...

3Wishes's picture

6 Trillion isn't that the same amount the PENTAGON can't find !

bada boom's picture

Is that what these ASSet managers call it.

The Duke of New York A No.1's picture

Central Bank bubble? ... or just doing God's work?.

Mass_hysteria's picture

The gangsters are looking out from their ivory towers...wow that's a long way down...we are about to screw so many people over with this fake stock market we created! Just smile and wave boys...smile and wave!

SloMoe's picture

I'd rather not see any of the current, or future, emperors without their clothes on, thank you.

hxc's picture

Unless Melania succeeds her husband. Then i'm down.

the grateful unemployed's picture

well if the corporate bond market is printing too much paper maybe old feddie weddie should buy a bunch of that paper like they do in europe. better call congress and get that charter passed so we too can have an all powerful central bank that can do whatever it takes, or at least say they'll do whatever it takes

buzzsaw99's picture

The Fed could continue to use its printing press to falsify capital market signals, but to what end?

You don't know? SRSLY? Think about it awhile, maybe it will come to you. (psst: it has to do with ceos and billionaires and such. you know, the maggots who own all that shit.)