The recent stock market downturn on Thursday likely didn’t surprise you. With the markets climbing steadily for nearly five months, a correction was expected.
This was especially true for technology stocks, which had soared to astonishing levels. The inevitable pullback came swiftly, with popular stocks like Apple, Tesla, and Nvidia all declining sharply—by 8%, 9%, and 9.3% respectively.
PagerDuty stood out as the day’s most significant loser, plummeting a staggering 25.8% from its previous high.
So, what should your next move be? Is it wise to buy the dip?
At this juncture, there doesn’t seem to be any compelling reason to invest in stocks. However, just like indulging in overpriced Yeezy sneakers or avocado toast, if purchasing high-priced stocks brings you joy, go for it. Just bear in mind that we are currently facing a reckoning. A monumental crisis is looming, and the state of the stock market should be the least of your worries.
Examining the Bigger Picture
To start with, U.S. gross domestic product (GDP) fell below $20 trillion in the second quarter, while government debt surged. The national debt now exceeds $26.7 trillion, with federal debt held by the public surpassing $20.5 trillion.
This situation is concerning for multiple reasons. First, the gap between national debt and GDP is continuing to expand. Second, public debt has now gone beyond 100% of GDP, an unsettling reality highlighted in a recent report by the Congressional Budget Office.
While the CBO projects that public debt will hit 98% of GDP by 2020, our calculations indicate that this threshold was crossed in June. Regardless, the crucial point remains: debt ratios approaching or exceeding 100% of GDP significantly impede economic growth. If debt is stifling growth, how can we expect the economy to climb out of this vast debt? Quite simply, it cannot.
Debt: A Widespread Issue
It’s important to remember that federal government debt constitutes only one part of the larger debt landscape. Other components, such as corporate, consumer, and state and local government debts, are at or near their historical highs.
For instance, U.S. corporations now owe a record $10.5 trillion to creditors in the form of bonds or loans, accounting for more than half of U.S. GDP. Similar to national debt, corporate debt has outpaced economic growth as well.
A recent BofA Global Research report reveals that corporate debt has surged 30-fold over the past 50 years, while U.S. GDP has only increased about 20-fold. Can corporate debt continue to grow disproportionately to the economy?
Not if our economic and financial systems were anchored by sound money. If that were the case, interest rates would have risen, and debt levels would have collapsed long ago. Instead, we are faced with the opposite: a system reliant on unsound, debt-based fiat money, where the supply can be manipulated like Silly Putty.
The Federal Reserve plays a significant role in extending the money supply. By doing so, it encourages debt levels that would otherwise be untenable. Moreover, this inflation of the money supply leads to investments in business ventures that may not be profitable.
Since the early 1980s, the Fed has generally pushed interest rates downward. Each decrease in borrowing costs prompts U.S. companies to take on vast amounts of new debt, effectively masking poor decisions from corporate managers. While the overall debt load may increase, the immediate impact on corporate balance sheets appears lighter.
Transforming a Corporate Credit Crisis into a Currency Crisis
The sustained drop in yields (which move inversely to prices) over the last several decades has contributed to an enormous bond market bubble. The demand for corporate bonds has been fueled by various sources, including foreign investors, investment funds (like mutual funds and ETFs), life insurance companies, and pension funds.
However, with corporate debt levels now surpassing half of GDP, the quality of corporate bonds is beginning to decline. Out of the $10.5 trillion in corporate debt, approximately $7.2 trillion is rated as investment-grade (AAA to BBB). Alarmingly, about $3.6 trillion of this is in the BBB rating category—only a notch above junk status.
A stagnant economy might lead to a flood of downgrades in BBB-rated bonds by credit-rating agencies, potentially overwhelming the smaller junk-bond market. As the long-term repercussions of government interventions unfold, we suspect that many companies’ credit ratings will deteriorate.
The Federal Reserve has the capability to escalate this situation into a full-blown catastrophe, transforming a corporate credit crisis into a currency crisis.
The CARES Act marked the Fed’s entry into the corporate bond-buying sector for the first time, acquiring bonds from some of the world’s largest corporations, including Toyota, AT&T, Apple, Verizon, GE, Ford, Microsoft, and many others.
We believe this was just an initial test. When the time is right, the Fed may stretch the money supply once again to prop up the $10.5 trillion corporate bond market, ultimately leading to a depreciation in the value of the dollar.
Sincerely,
MN Gordon
for Economic Prism
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