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Death by Leverage – Paul Price – Market Shadows

America’s national debt exceeded $15 trillion [with a T] for the first time on November 15, 2011. Deficit spending since then has pushed the total national debt closer to $17 trillion. 

National Debt as of May 31, 2013

With an official population of 316,110,225 every man, woman and child in America now owes $52,953 plus future interest costs. It should be noted that this does not include enormous unfunded liabilities for Social Security, Medicaid/Medicare or the potentially crippling burdens of ObamaCare.

US population June 23, 2013

Incremental debt is being added at an unprecedented rate.

The Treasury bond auction market tells us nothing about the true state of interest rates as shill bids from the Fed have sucked up virtually all net government bond issuance this year.

Pace of Debt chart

Europe is already in recession and drowning in debt. There are no solutions on the horizon. The idea that the Fed will cut back on money printing/bond buying programs is pure fantasy. The politically expedient solution still suggests QE continuation or even expansion, both here and abroad.

The only alternative is the outright confiscation of wealth. That technique was beta-tested just months ago in Cyprus.

Pundits are screaming about the risk they see in the equity markets. However, stocks are not overpriced. Bubble valuations currently reside in the fixed income arena, and bonds appear riskier than stocks. Shares of highly levered companies have benefited from artificially low rates by refinancing old debt. They have also borrowed to pay for massive share buyback programs. Those times may be coming to an end.

Bond Bubble     June 21, 2013

A new credit crunch, or a freeze, may be brewing that could be worse than what we saw in 2008. There is no way to know, but we should be preparing ourselves for that eventuality.

Holders of long-term bonds are taking huge risks. A 1% rise at the long end of the yield curve could send 30-year bond prices down 17%. A 2% increase could drop principal values much more that. Years of coupon payments could be wiped out on a total return basis.

Long maturity corporate paper issued just weeks ago as part of Apple’s (AAPL) $15 billion debt offering have already been marked down by over 10%. Avoid all bonds if possible. If you must keep any fixed income vehicles be sure they have short maturities.

2008 taught us that highly leveraged companies, or healthier ones with even moderate levels of maturing debt, can be forced to issue dilutive shares or descend rapidly into bankruptcy. Make sure companies you own stock in have enough predictable cash flow to service all bond interest as well as principal payments coming due within the next few years.

In extreme conditions, even top-rated firms can be forced into coercive terms if they need to refinance when money is tight. For example, in 2008, Berkshire Hathaway extracted 10% interest plus warrants from Goldman Sachs, GE and others. The next cycle could precipitate more punitive terms.

Check balance sheet data by consulting subscription services such as Value Line, S&P or Morningstar. Free sites like Yahoo Finance and MSN MoneyCentral also offer access to up-to-date financial information. A firm that cannot meet its bond obligations is at the mercy of its lenders.

Ensure that your own portfolio is unlevered. Debt-free portfolios can wait out any temporary storms. It’s also helpful to be able to add to holdings after a major selloff.

Stick with shares of financially strong companies with rock solid balance sheets. I like the companies included in our Virtual Value Portfolio, especially stocks that are trading at prices close to where we initially added them.


Skating on Thin Ice, Keep Life Preservers Handy

We may be skating on very thin ice here, but the weight of the evidence still supports a weak bull case for the near to intermediate term. So I’m adding buy picks on the chart pick list and adjusting trailing stops to account for the risk.

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These reports are not investment advice. They are for informational purposes, for a broad audience of investment and trading professionals, and other experienced investors and traders. Chart pick performance changes week to week and past performance may not indicate future results, as you know. Trading involves risk, and these reports assume that you understand those risks and manage them according to your tolerance. 

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