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Originally Posted by lustylad
Boardman - good analysis but I am not as worried about a stock market crash as you are. As long as corporate earnings are strong, stocks will remain attractive. A good yardstick to keep an eye on is the average P/E ratio for stocks in the S&P 500. If it stays around 15-20x I don't see a big problem. Earnings put a floor under the market. The reason the market crashed in 2008 is because the economy went into free-fall. Nearly all businesses experienced a sharp drop in sales or revenues, in many cases wiping out earnings because the firms couldn't reduce costs as fast as they were losing revenues. Investors fled stocks until they felt confident that the drop in sales/revenues had bottomed out in 2009, allowing companies to start reporting profits again.
Also, I disagree with your assertion that "stock is a way of borrowing money". That's way too simplistic and doesn't allow for the concept of risk and the huge differences between debt and equity. If you issue debt, you have a legal obligation to pay the interest - otherwise your creditors can force you into bankruptcy. If you issue equity, you can always cut/suspend dividends in a downturn and stay in business. That's why firms in highly cyclical industries should rely more on equity (and less on debt) to finance themselves.
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I think the earnings will suffer enough when the interest rate rises. Interest expense is negligible on income statements right now. When it becomes a significant expense earnings will take a hit. In order to minimize that hit they will begin selling that stock at inflated prices that they caused. At first it will be a good way of paying down the debt and reducing the interest rates but I'm afraid many of the corporations are too leveraged in the cheap money and won't be able to recover quickly enough to keep their stock prices from suffering. Sure they will have released the stock to the public so they get their money back but then if adjustments occur because of new earnings reports that don't support the inflated prices people paid for the stock then things start to go down hill.
Those same interest rate rises will obviously affect the servicing of the government debt causing one of three things to happen. Significantly higher taxes, significantly decreased spending or default. I don't think default is a realistic option. Decreasing government spending, while in the long run, would be the best solution we are not willing to go through that kind of pain. That leaves increased taxes.
I want to see a broader tax base but the Democrats will not let that happen if they have any say so. The easiest way to raise taxes, especially in crisis is to point to the recent past earning of corporations and make them out to be the villains as well as the panacea even though their current situations are not nearly as strong as they were before the interest rate hikes. Raise taxes on the corporations and it's the same as raising taxes on everyone because the price of their product or service goes up. If discretionary spending decreases, GDP falls and were in a free fall until it either stops or the government steps in. When the government steps in it is always a band aid, never a cure. TARP is a good example of kicking the can down the road.
As to your second statement, obviously firms that rely more on equity are healthier in the long run. They are in control of what happens and they are using "their" money. However, when interest rates are as low as they are it entices corporations to supplement their operational earnings by issuing debt while paying very little interest and using that debt to buy back their own stock and keep the dividends. They are willing to pay inflated prices for their own stock in order for that to happen because as long as the earnings are good then they get to keep them and it really doesn't matter what the stock price is. That strategy only works for so long though. At some point they own all the stock and assume all the risk at which point any hiccup in the economy puts them at risk by lowering the value of the stock they own or they start minimizing their risk by putting the stock back out and then are subject to corrections in a volatile market. Provided they are in a good cash position then they can whether the storm.
Much of our problem today is that many corporations are and have been in a good cash position for far too long, since about 2010 and are keeping that cash offshore and hoarding it for the next crash so they can survive it. That's cash that would otherwise naturally stimulate the economy if it were being spent here on capital expenditures and increased wages but we are sending those jobs overseas and much of the PP&E is being bought, or worse, leased over there because of the economic climate we have created here. It's a huge circle that we can't get out of without significant short term pain.
