Preface: Optimal levels of equity in business are the result of fiscal disciplines. High debt to equity ratio enterprises are subject the to credit risks outlined in the following blog.
Looking Into 2018 — Credit Slopes
Historic business data provides a clear cyclical history. That data history yet differs in the timeframes of the effective expansion and contractions in the economic forces of supply and demand, fueled from credit driven consumption and credit driven business investments. Looking at the fundamental driver of business strategy, e.g. increased revenue, increased profitability, standard revenue increases are the result of greater assets investment, and greater asset output. While output can increase, e.g. manufacturers produce more skis, the demand for skis must be sufficient to sustain the increase in the levels of production. During business expansion cycles, demand outpaces supply, encouraging the growth of production, i.e. more skis sold, and more income.
The business cycle of skis is a small sub-segment of the greater business environment, but easily comprehensible. For ski manufacturers to succeed, several market catalysts must be in place, 1. Snow 2. Interest in recreational winter activities, 3. Consumer capacity to enjoy. If alpine ski businesses powered the stock market, the higher the lift, the more exciting the black run.
David Stockman, former Reagan White House Budget Director and former Congressman, thinks the current business cycle will experience a fiscal calamity of Biblical proportions, a financial reset in future years. To quote Stockman, “The Central Banks realize they cannot keep printing money at these crazy rates, and by that I mean bond buying. Now they are going to have to normalize and shrink their balance sheet….by the end of 2018 it will $600 billion a year”.
In understandable terms the artificial snow creation on at the Federal Reserve’s economic resort cannot last all year. They skiing has been great, and sooner or later, the slopes will vacate for summer. This is to say that the again, a credit driven economy, resulting from Federal Reserve balance sheet expansion, same as artificial snow creation, is perpetually unsustainable in most US States. The Federal Reserve has been printed money and purchasing bonds on an overtime schedule since 2008, thereby financing investments and taking the bond markets up the lift. This market effect is an interest rate decline until the present time.
What happens if that trend is sustained? Inflation occurs, and a decline of the currency value from the dilution of the aggregate Federal Reserve notes, causing imported purchases to increase in cost in a global marketplace.
Stockman’s concern is how the US will balance its budget, with a decrease in revenues, e.g. The Tax Cuts and Jobs Act, recently approved by Congress. “Were talking 2019…..You’re facing not in the distance future, and not in the by and by way down the road…in 2019 the next fiscal year….a 1.2 trillion dollar deficit”. Stockman says in the next recession, the US budget deficit will really increase. “The stock market operation on the illusion of permanently low, ultra-low interest rates,” Stockman continues.
When interest rates rise, will the business environment be sustainable, or will stock market and bond markets will collapse with a massive debt reset. Maybe not in 2018, but economic ski slopes will eventually vacate again with the typical seasonality of the business cycle. Start preparing for a return to business as usual if you’re skiing on credit at the Feds resort. That’s the gist of Stockman’s advice. It will require a longer time than anticipated for most businesses to get to bottom of slopes.
This blog is not to be construed as investment, legal or accounting advice. It is for informational purposes only. Please talk with your trusted advisors before making any decisions.