Author Archives: Jeff Peshut

Is There Really A Corporate Debt Bubble That’s Ready To Burst?

By Jeffrey J. Peshut

December 3, 2018

Over the past several months, media headlines have been awash with dire warnings of a looming corporate debt bubble that is about to burst. Some of the more provocative headlines include:

From the perspective of Austrian Business Cycle Theory. this post will explore the questions of whether there really is a corporate debt bubble — and, if there is, when we can expect it to burst. But first, let’s define corporate debt.

Corporate Debt

According to Federal Reserve Statistical Release Z.1, Financial Accounts of the United States, the non-financial “corporate business debt” sector consists of all private for-profit domestic non-financial corporations. S Corporations, which have 35 or fewer stockholders and are taxed as if they were partnerships, are included in this sector. Corporate farms are also included. Holding companies and equity real estate investment trusts (REITs), which are considered financial businesses, are excluded from this sector.

Corporate Business Debt outstanding totaled $20.2 trillion at the end of 2017, an increase of $7.3 trillion from the cyclical low of $12.9 trillion at the end of 2009. (See Figure 1.) This reflects a 56.6% increase over that eight-year period.

Figure 1: Corporate Business Debt ($000,000) 1978 – 2017

The $20.2 trillion of outstanding Corporate Business Debt includes debt securities that include Corporate Bonds ($5.4 trillion), Municipal Securities ($568 billion) and Commercial Paper ($207 billion), Foreign Direct Investment in U.S. ($3.9 trillion), loans that include Depository Institution Loans ($1.0 trillion), Other Loans and Advances ($1.3 trillion) and Total Mortgages ($522 trillion), Trade Payables ($2.5 trillion) and Miscellaneous Liabilities ($4.6 trillion). (See Figure 2.)

Figure 2: Corporate Business Debt By Sector 2017

The year-over-year percentage growth of Corporate Business Debt from 1978 through 2017 is presented in Figure 3. This chart vividly illustrates the cycles in Corporate Business Debt over the past 40 years. Note the cyclical peaks in its growth rate of 12.8% in 1984, 14.3% in 2000, 9.26% in 2007 and what will likely be the peak for the current cycle of 7.95% in 2015 and the cyclical troughs in its growth rate of 6.33% in 1982, 2.12% in 1991, -.56% in 2003 and -2.43% in 2009. The cyclical trough for the current cycle has yet to be revealed.

Figure 3: Corporate Business Debt (YOY%) 1978 – 2017

Non-Corporate Debt

The non-financial “non-corporate business debt” sector consists of partnerships and limited liability companies (businesses that file IRS Form 1065), sole proprietorships (businesses that file IRS Schedule C) and individuals who receive rental income (income debt reported on IRS Schedule E). Non-corporate farms are included in this sector. Investment properties owned by individuals and the corresponding mortgages are also included in this sector.

Companies in this sector are not necessarily small, but they generally do not have access to the debt securities markets like companies in the corporate business debt sector and thus rely on loans from commercial banks, trade credit and other credit providers for funding. When it comes to dealing with finances in any industry, the idea of finding out as much as you can beforehand can make all the difference. From looking into the idea of income ratios when home buying, to even finding out how to deal with finances for your business, this is all vital information that we all should be aware of, especially as the economy is always changing.

Non-Corporate Business Debt outstanding totaled $7.5 trillion at the end of 2017, an increase of $1.9 trillion from the cyclical low of $5.6 trillion at the end of 2011. (See Figure 4.) This reflects a 33.5% increase over that six-year period.

Figure 4: Non-Corporate Business Debt ($000,000) 1978 – 2017

The $7.5 trillion of outstanding Non-Corporate Business Debt includes Total Mortgages ($3.8 trillion), loans that include Depository Institution Loans ($1.3 trillion), Other Loans and Advances ($206 billion), Trade Payables ($672 billion) and Unidentified Miscellaneous Liabilities ($1.4 trillion). (See Figure 5.)

Figure 5: Non-Corporate Business Debt By Sector 2017

Figure 6 presents the year-over-year percentage growth of Non-Corporate Business Debt from 1978 through 2017. Similar to Figure 3, Figure 6 clearly shows the cycles in Non-Corporate Business Debt over the past 40 years. Note the cyclical peaks in its growth rate of 14.12% in 1984, 16.50% in 1998, 14.93% in 2005 and what will likely be the peak for the current cycle of 6.22% in 2014 and the cyclical troughs in its growth rate of 4.30% in 1987, -1.58% in 1991, 2.18% in 2003 and -1.11% in 2009. Again, the cyclical trough for the current cycle has yet to be revealed.

Figure 6: Non-Corporate Business Debt (YOY%) 1978 – 2017

Combined, the $20.2 trillion of “corporate business debt” and the $7.5 trillion of “non-corporate business debt” make up the total business debt of $27.7 trillion.

True Money Supply

Followers of the Austrian School of economic thought and regular readers of RealForecasts.com understand that changes in monetary policy by the Federal Reserve System’s Federal Open Market Committee (FOMC) and the resulting rate of change of U.S. Base Money, Commercial and Consumer Lending and the Money Supply can be used as leading indicators to accurately forecast changes in the economy, financial markets and real estate markets. (See, Does The Federal Reserve Really Create The Boom/Bust Cycle?) Therefore, to determine whether there is a corporate debt bubble that’s ready to burst, it’s helpful to look to changes in the rate of growth of the Austrian measure of the money supply, also known as the True Money Supply or TMS.

At the end of 2017, the True Money Supply totaled $13.1 trillion, an increase of $8.0 trillion from the cyclical low of $5.1 trillion at the end of 2006. (See Figure 7.) This reflects an astounding 156.9% increase over that 11-year period. To put that into perspective, TMS increased from the cyclical low of $3.0 trillion in 2000 to $5.1 trillion in 2006, an increase of “only” $2.1 trillion or 70% during the height of the most recent housing bubble. Is it any wonder that we’ve seen such exponential increases in asset values since the institution of Quantitative Easing?

Figure 7: True Money Supply ($000,000) 1978 – 2017

The year-over-year percentage growth of TMS is shown in Figure 8. Note the cyclical peaks in the TMS growth rate of 36.66% in 1983, 13.27% in 1992, 18.00% in 2001, and what will likely be the peak for the current cycle of 14.49% in 2011. Also note the cyclical troughs in the TMS growth rate of -1.63% in 1989, -2.11 in 1994, 2.61% in 2000 and 1.66% in 2006. Based upon the precipitous drop in the TMS growth rate over the past year and the Fed’s current monetary stance, the next cyclical trough in the TMS growth rate is likely not too far off.

Figure 8: True Money Supply (YOY%) 1978 – 2017

Corporate Debt vs. True Money Supply

The relationship between changes in the growth rate of Corporate Business Debt and the True Money Supply is set forth in Figure 9. Generally, the trough in the growth rate of Corporate Business Debt lags the trough in TMS by about three years. If this relationship holds true for the current cycle, the growth rate for Corporate Business Debt should reach its next trough in the 2021 to 2022 time-frame.

Figure 9: Corporate Business Debt (YOY%) vs. True Money Supply (YOY%) 1978 – 2017

Conclusion

Although the analysis presented in this post indicates that the growth rate of Corporate Business Debt reached its cyclical peak in 2015 and that the growth rate of TMS is nearing its cyclical trough, the three-year lag between the growth rate of Corporate Business Debt and the growth rate of TMS suggest that the growth rate of Corporate Business Debt won’t reach its next cyclical trough until the 2021 to 2022 time-frame. Therefore, warnings that a corporate debt bubble is ready to burst seem premature.

What Does The Dramatic Deceleration In The Growth Of The True Money Supply Mean For Real Estate Investors?

By Jeffrey J. Peshut

February 21, 2018

On February 5, 2018, Jerome Powell was sworn in as the 16th Chair of the Board of Governors of the Federal Reserve System.  Powell succeeded Janet Yellen, who was sworn in as Fed Chair on February 3, 2014, a little more than a month after the Federal Reserve ended its asset purchase program commonly referred to as Quantitative Easing or “QE” for short.

In November of 2014, in response to the end of Quantitative Easing and Janet Yellen’s appointment as Fed Chair, RealForecasts.com published a post titled How Will The End Of Quantitative Easing Impact The True Money Supply Growth Rate?  In that post, RealForecasts.com forecasted a deceleration in the growth of the True Money Supply (TMS) from about 9% year-over-year (YOY) at the beginning of 2015 to 0% YOY at the end of 2016.

This post will update the actual growth rate of TMS since the end of QE and explain what it means to real estate investors.  It will also provide some possible strategies that real estate investors can adopt in response to changing economic and real estate market conditions.

True Money Supply Growth Rate Since The End of Quantitative Easing

As suggested above, the Federal Reserve ended Quantitative Easing in December of 2013.  Two years later, in December of 2015, the Fed began raising the Fed Funds Target Rate — with an initial increase from .25% to .50%.  This was the first time that the Fed had raised the Fed Funds Rate since June of 2006.

During this two-year period, TMS grew at a remarkably consistent rate of about 8% YOY.  The steady growth of TMS continued during the first half of 2016 and even accelerated briefly to 11.15% YOY in October of 2016.  (See Figure 1.)

Figure 1: True Money Supply (YOY%)  01/01/08 – 12/31/17

In December of 2016, and in March, June and December 2017, the Fed continued to increase the Fed Funds Rate in 25 bps increments to its current rate of 1.50%.

Moreover, on September 20, 2017, the Fed announced that it would begin to reduce the $4.5 trillion balance sheet that it had amassed during QE by selling $10 billion of assets each month from October through December of 2017, $20 billion per month from January through March of 2018, $30 billion per month from April through June of 2018, $40 billion per month from July through October 2018 and $50 billion per month from October through December of 2018 for total sales of $450 billion by the end of 2018.  The Fed also announced plans to raise the Fed Funds Rate three more times during 2018 to end the year above 2 %.

In response to the Fed’s increasingly tighter monetary stance, the growth rate of TMS has decelerated dramatically, from 11.15% YOY in October of 2016 to 3.10% YOY in December of 2017.

This is the same magnitude of deceleration that RealForecasts.com had forecasted in November of 2014, but because the Fed unexpectedly delayed its decision to begin raising the Fed Funds Rate and reduce its balance sheet, it occurred about a year later than expected.  Note that this is the most dramatic deceleration during a period of monetary tightening since TMS decelerated from 9.54% YOY in October of 2004 to 1.71% YOY in November of 2005.  (See Figure 2.)  In that case, after accelerating slightly from December of 2005 to April of 2006, the TMS growth rate decelerated to its cyclical low of ,98% YOY in September of 2006.

Figure 2: True Money Supply (YOY%)  01/01/03 – 12/31/17

If the Fed sticks with its plans to continue to both raise the Fed Funds Rate and reduce its balance sheet during 2018, it’s easy to see that the growth of TMS could grind to a halt and even begin to contract later this year.

What Does This Mean For Real Estate Investors?

In previous posts such as Where Are The Employment Markets In Their Cycles? and Where Will Commercial Real Estate Returns Go From Here?, RealForecasts.com demonstrated that changes in the TMS growth rate can accurately forecast changes in the growth rate of Total Employment.  Further, because of the the strong correlation between the YOY growth rate of Total Employment and the annual returns from private-market real estate equity investments, as reflected in the NCREIF Property Index (NPI), changes in Total Employment can help us to forecast changes in the NPI.

Figure 3 shows the acceleration and deceleration of the expansion — and sometimes contraction —  of TMS  dating back to 1978.  Note that in each TMS expansion and contraction cycle, the Fed maintained a tight policy stance until a credit and liquidity crisis occurred.  Also, an economic recession typically occurred shortly after the credit and liquidity crisis.  Finally, of particular note is the length of the loose policy stance in the current cycle and, until recently, the slow pace of tightening since the end of QE.

Figure 3: True Money Supply (YOY%)  01/01/78 – 12/31/17

RealForecasts.com expects that the growth of TMS will continue its downward trend in the months ahead, as the Federal Open Market Committee continues to raise the Fed Funds Target Rate and reduce its balance sheet.  Based upon the current trajectory of this trend, and the Fed’s current policy stance, it looks like the next credit and liquidity crisis could occur during the second half of 2018, with an economic recession and real estate market downturn to follow.  Of course, this forecast could change if the Fed changes its policy stance or if the commercial banks change their pace of lending activity.

In the meantime, real estate investors would be wise to take advantage of the still robust capital markets environment to begin selling some of their under-performing and less-strategic assets and using the proceeds to reduce the leverage on their remaining properties and portfolios.  By “dealing from the bottom of the deck” and reducing leverage, they will be improving the risk profile of their portfolios in anticipation of — and not in reaction to — the next credit and liquidity crisis, economic recession and real estate market downturn.

Many thanks to Michael Pollaro at The Contrarian Take for providing the TMS data used in this post.