Debt Bubble

As a clarification to a previous article, I showed a chart which had an elevated level of equity financing as a percentage of U.S. M&A. It’s worth emphasizing that while equity issuances have been funding M&A at a high level, net equity issuance is the lowest since 2007. As you can see from the chart below, right before the financial crisis, debt was issued to fund a massive amount of buybacks. History is repeating itself as the current corporate debt issuance is almost as high as 2007 and the current net equity issuance is almost as low as 2007. This chart shows the debt bubble in its glory.

The chart below takes another look at the debt bubble. It shows the total nonfinancial debt as a percent of GDP. The debt never unwound after the 2008 financial crisis; now it is higher than ever. This lack of an unwind is why I think the next recession will be much worse than the last one. The economy needs to deleverage. A real deleveraging would send the debt as a percentage of GDP close to the average which is 169.4%. The debt per dollar of GDP in 2016 was over double the debt per dollar of GDP from 1952-1999.

Shorts An Endangered Species

The stock market likes to deliver the most pain to the most investors. It delivered pain to short sellers in 2016 as they piled in to their shorts in the beginning of last year only to be met with a strong rally. This year short sellers in long bonds have been crushed. When there are some short sellers left in a bull market, it signals the bull market has room to run higher. When the shorts have covered and moved on to a new occupation, it signals the bull market is on its last legs. The chart below illustrates this point. There was a high short interest in late 2015 and early 2016 as short sellers thought the selloff would precede a recession in 2016. At the end of March short interest was down 20.1%. The decline in shorts should worry bullish investors especially since the market has been weak lately.