The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]

Heard just now on Continual New Bull ****

"We put a 4.5% 10 year into our models to stress test the market and it is still cheap because earnings are growing at 10-12%."

Uh huh.

His model is ****ed, to be polite, yet nobody called him on it.

The reason "earnings" are "growing" like that is that companies are buying back stock and otherwise funding operations with debt.  This "gooses" EPS but it adds deferred costs to their balance sheets at the same time.  How do we know this is going on?  Because C&I debt (non-financial) has gone from $11.2 to $13.9 trillion, an increase of $2.7 trillion dollars, from 2008 to today.

That borrowed money is levered up at ridiculous ratios through this sort of game to produce the so-called "results."  The problem with goosing EPS with buybacks is that each dollar of earnings produces more EPS, but at the same time if there is a loss the same multiplication of that loss in EPS will occur!

Further, this game only makes sense (and only works) so long as rates are extremely low.  Said debt has a term structure, and when that term structure expires it either must be paid back (the principal!) or it must be rolled over.  That liability is real; someone else owns the other side of it as an asset and it cannot be made to "disappear."

If rates rise then that entire term structure becomes untenable to maintain; as the expiration date comes if the debt is rolled the interest expense becomes punitive and destroys EPS; if not then the capital hit required to pay off the debt destroys EPS and, again, the lower share count means the impact is multiplied exactly as it was on the way up!

If you program your "model" to ignore that then there's no scenario under which anything can go wrong.

How did that work out for you in 2008?

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