A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

“Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt and leverage increased.”

Vaccine Cure Widow-Maker, A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

As stated, the sectors believed to be part of the “value trade” requires stronger economic activity. Such would lead to higher rates of inflation and higher interest rates.

As rates rise, so do rates on credit card payments, auto loans, business loans, capital expenditures, leases, etc., while also reducing corporate profitability.

In an economy supported by debt, rates must remain low. Therefore, the Federal Reserve has no choice but to monetize as much debt issuance as is needed to keep rates from substantially rising. The byproduct of those actions is weaker economic growth and lower rates of inflation. As shown, since 2009, inflation has consistently run well below the Fed’s target.

Vaccine Cure Widow-Maker, A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

Unfortunately, higher levels of debt continue to retard economic growth keeping the Fed trapped in a debt cycle as hopes of “growth” remain elusive. The current 5-year average inflation-adjusted growth rate is just 1.64%, a far cry from the 4.79% real growth rate in the ’80s.

Vaccine Cure Widow-Maker, A Vaccine Won’t Cure The 20-Year “Widow-Maker” Trade

“vaccine” for COVID-19 is entirely different than what is needed to cure the “debt problem.” 


The Rotation Is Likely Short-Lived

Look back at the first chart above. Based on two-year forward earnings estimates, the Russell 2000 (small-capitalization companies) are trading at historical extremes. Compound valuation problems, with the debt problem, and the lack of actual “value,” the issue becomes more apparent.

Given the Federal Reserve’s monetary injections and suppression of interest rates, it is not surprising to see companies leveraging their balance sheets. As interest rates have plunged, corporations have hit a record issuance of debt to pay dividends and engage in other non-productive actions.

The increased leverage of corporate balance sheets is problematic, particularly given already weak revenue growth for S&P 500 companies.

The rotation from “growth” to “value” is inevitable. With that, we agree.

However, a  “vaccine” doesn’t solve the problems plaguing economic growth, suppressing inflation, and keeping Central Bankers flooding the markets with liquidity. 

Those problems can only get solved against a backdrop of devastation for the majority of investors. When there is a true reversion in leverage, debt, and valuations, the foundation for a “value rotation” will be laid.

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