The stock market was down Monday. The S&P 500 is down about 1% from its all-time high. Anytime the stock market has been down since the election, it’s bigger news than it normally would be because it’s been in almost a straight line higher. It is difficult to remember what a normal market is like because we’ve been in an abnormal market for quite some time. The earnings metric I will mention later which uses 5 and 10 year averages is now distorted because the market has gone awry due to central banks’ accommodative policies. The distortion can be described by the combination of expanding market multiples and expanding debt levels. Stocks have gotten more expensive while firms are borrowing more to push their earnings higher with buybacks and acquisitions funded by cheap debt.

The chart below shows the 12-month change in the S&P 500 p/e ratio going back to late 1979. As you can see, the p/e ratio increases and decreases because of fluctuations in earnings and stock prices. While this current cycle never saw a spike higher in the market multiple like in other cycles, this has been the longest streak of multiple expansion in the past 37 years. 57 months of multiple expansion has left us with a Shiller PE of 29.27; the median is 16.12.

Even though earnings paint a relatively bleak picture for stocks it’s not a full description of the situation because, as I said, earnings are being boosted by the issuance of cheap debt. The number of publicly trading firms is declining because of acquisitions by larger firms. It’s doubtful this helps the economy since it leads to less competition and fewer jobs, due to synergies. It’s also doubtful that buybacks help the economy when the stocks are purchased at elevated levels. These poorly timed purchases make the peaks higher and the troughs lower (because the equity is re-issued at troughs). The catalyst for these two trends is cheap debt which makes earnings look better than they are. As you can see from the chart on the left, the median net debt to EBITDA of investment grade firms is now near the cycle high seen in 2002. The debt ratio has started to fall which is very strange because it has previously fallen after stocks corrected in the past two cycles.