Blog | CB Investment Management

Stock Market Rally Attribution. Debt Dependence. Cyclical risk.

A clearer idea of the main drivers of the multi-year US stock market rally provides new insight about its durability and substance. The main causes of the rally can materially change perspectives about the outlook.

Cycles allow for both bulls and bears and provide a focus on the catalysts for a shift between the two. When growth is strong, underlying issues don’t seem to matter. However, once growth has peaked underlying problems can return to a more dominant concern.

After examining attribution, I believe the next down cycle in the US economy is important not to miss. In my opinion, US debt dependence is extreme, and so the degree of fragility in the financial system is far greater than is widely understood.

After the tax reform boom in the US equity market, what will follow to keep up that level of stimulus? Already, there are signs that a US down cycle could be beginning.

There are only a few main macro sources for equity market gains, broadly covered under these four headings.

1. Interest rates
2. Revenues
3. Corporate profits
4. Debt (EV/revenues + budget deficit)

Interest Rates have been at record lows for most of the last several years in both absolute and real levels.


However, they have been lower and for longer in both Europe and Japan, and have have little effect on those domestic markets. Also the US stock market has accelerated its rally over the last 2 years as interest rates rose. So its not interest rates.

Revenue growth has been weak and the stock market has massively outperformed revenues/sales, as the chart below shows. So not revenue.

Corporate profits after tax do show some improvement in the last 2 years but have made only a marginal new high relative to 2014/5, so like revenues they have massively underperformed the stock market.

Before tax corporate profits have been even weaker. Failing to make a new high and look sideways since 2012.

It also looks unlikely that many more tax reform bills can help. The tax reform bill clearly made a difference, roughly halving corporate tax receipts.

However, this hit to tax revenue has taken the ratio down to new lows in relation to federal debt. There may not be much room for more corporate tax breaks.


Debt is the only remaining macro factor. Already we have seen that the tax reform bill did have an impact, but with interest rates rising, and the budget deficit already rising back into the Trillion plus level and the ratio above already very stretched, there is not much room left.

Indeed corporate profits have already become more dependent on the budget deficit than ever before. Since 2008 Federal Debt growth has consistently exceeded GDP growth , cumulatively by $9 Trillion!

Without the Federal debt explosion GDP would have been far weaker than it has been, and corporate profits too! Corporate profits are, therefore, now hugely dependent on federal debt expansion.

However, it turns out that corporations have also massively increased their own debt.

Corporate debt explosion too!

Closer scrutiny also shows that a number of stocks have had explosions in EV, enterprise value, relative to revenues. EV is market capitalization plus debt, so debt and buyback engineering is clearly a huge part of the stock market story.


For the FANG stocks above, EV to revenue has more than doubled in recent years! Mean reversion when the debt can no longer finance buybacks would likely be significant.


Alarmingly, this concept spreads far beyond just th FANG stocks. To make this point clearer, a composite of EV to revenue was created for 4 Dow Stocks, BA, MCD, CAT, and MMM, in the chart above.

Even here it can be seen that EV to revenue more than doubled, and this was on DECLINING revenue!

Surely, there is a limit on debt to revenue somewhere. The chart below shows that corporate debt is now back to bubble extremes.


The stock market rally since 2009 has hugely depended on both federal and corporate debt. Before tax profits have barely moved since 2012, but debt has continued to rise, so the US stock market has become increasingly dependent on debt, even just to maintain existing profits.

A down cycle in the US would be problematic, but a global down cycle is already in place and debt seems to be tapped out in the US.

To assess the probability of a US down cycle we can examine:

1. Market signals.
2. What cycle experts are seeing.
3. The difficulty of just maintaining the current explosive upcycle.
4. Measuring the shape of the global downturn.

Market Signals

It is well worth reviewing the structure of the rally more deeply. Stocks like AMZN, which paid no tax in 2017, and AAPL are the clear standouts, the two first ever Trillion dollar market cap stocks!

However, finding great performance beyond this soon gets hard, and even the NDX (Nasdaq 100) is showing clear divergence too.

The link above shows that this divergence goes much further beyond NDX. Lack of upside participation is an important sign of trouble with the market rally.

What cycle experts are seeing.

ECRI’s U.S. Weekly Leading Index growth rate slips to -0.2%.

Laksman Achuthan explains why this is important for US equities.


The difficulty of just maintaining the current explosive up cycle.

Keith McCullough explains the difficulty of following up a 35% increase in technology stock profits without a reset.

He also explains why if the yield curve inverts, you don’t wait for a recession to take action.

Measuring the shape of the global downturn.

No economy is more key to the outlook for global growth than China. Darius Dale explains the current outlook.

The Shanghai market is down 22% YTD as at 09/10/2018.


Investors should come up with their own probabilities and timing for a US downturn. Given the extent of debt dependence in the US and the limits to further debt growth from current levels, this is clearly a crucial assessment and it’s time for a strategy review.

Best Practice is a matter of your Best Interest.

Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

Sign up to receive the best practice community insights directly into your inbox

Leave a Comment

Your email address will not be published. Required fields are marked *

Related Posts

Sign up to receive the best practice community insights directly into your inbox