What do 0% interest rates and Bitcoin have in common? Both spawned out of the 2008 Financial Crisis. Both having seemingly proven to stand the test of time to date, but we have yet to see their long term implications. Some say Bitcoin and crytpocurrencies are the future, others say it’s a bubble. Some say the stock market is overvalued and due for a correction, others believe the market is poised for further growth. While we don’t know what the future holds for either, it is safe to say something is going on…something big…

Call me crazy, but I believe a stock market correction in the imminent future is very real. I also believe that such correction could lead to massive inflows of institutional dollars into the cryptocurrency market. Why? Well, depending on how you slice it one could argue the S&P500 is overvalued. Overvalued and inflated by prolonged periods of artificial earnings growth through corporate buybacks; buybacks which have been funded by cheap debt as a result of a zero interest rate policy (ZIRP) by the U.S. Federal Reserve. On the other hand, we’ve seen an entirely new SPECULATIVE market emerge in 2017 with lots of new capital being put to work.The possibility of this new technology changing the way we transact, store value, and conduct business is very real…yet very nascent. Some are realizing this sooner than others, heads are starting to turn…

Cheap Debt and Expensive Equity

The U.S. Federal Reserve has two jobs: maintain a healthy level of inflation and keep the labor market afloat. The Fed achieves this through its interest rate policy. From 2008 to 2015 the Federal Reserve set interest rates to 0%, an unprecedented level. When interest rates are low people will yield lower interest on savings, but borrowing money becomes cheaper and easier (such is also true for businesses). A more attractive lending environment means an economy’s money supply will tick up and more spending will take place, thus fostering economic growth. But what goes up must come down. It can be said that 7 years of cheap debt has led to dangerous levels of corporate leverage and this has purported artificial earnings growth.

When a business buys back its stock, the company is signaling to the market that their stock is cheap. This ultimately leads to greater returns to share holders (assuming earnings growth remains flat at the very least) because there are fewer outstanding shares to divvy up shareholder’s returns. This directly impacts the price-to-earnings ratio (a popular metric used by Wall St. to determine if a stock is over/undervalued) of a stock. It causes the ratio to look optically lower and a more attractive investment. Sometimes buybacks are funded by cash on hand, sometimes debt. But, there comes a point when amassing debt in exchange for share buybacks, as opposed to funding capital expenditures & working capital, becomes toxic. A shocking +40% of the EPS growth and +30% of the stock market gains since 2009 are estimated to be from share buybacks. Since 2009 companies have spent a record $3.8 trillion on share buy backs financed by historic levels of debt issuance[1]. While the S&P500 may look cheap on a P/E basis, if you factor in share buybacks and screen on other metrics (EV/EBITDA, P/B, P/S) the S&P500 looks expensive.