The rampage in stocks knows no bounds. The Nasdaq, Dow, and S&P 500 all hit record highs on Wednesday even though Apple was down on the day. As you can see from the chart below, the total returns in this bull market just passed the 1950s rally. This is now the third largest rally in history. That is fitting because the Shiller PE is the third highest ever. The possibility of tax reform is the gift that keeps on giving. Paul Ryan announced his tax plan will be released September 25th. It’s weird to delay the plan another 2 weeks; this isn’t a product launch, it’s a potential law. Either way, the market loves the idea of tax cuts. The devil is in the details because corporate taxes paid are less than the statutory rate. A lowered rate and less deductions could be a hike. I’m not saying that will happen, but it emphasizes the point about the effective rate being more important.  This could be a case where stocks buy the rumor and sell the news. Stocks aren’t pricing in the massive tax cuts which were promised during the campaign because that’s unlikely to occur given the high deficits already being racked up.

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One of the strongest bearish arguments to go along with the high valuations is seen in the chart below. The credit markets determine the health of the economy. The recent decline in the worldwide new credit growth as a percentage of GDP shows the global economy might slow in the next few months. It predicted the recent upswing which has been led by emerging markets, so it’s worth keeping an eye on. While the credit issued is down, it’s still above the percent change before the prior two recessions, so 2018 could be weak like 2015-2016 instead of a recession.

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The chart below gives you an idea of where investment managers are expecting profit growth to be the most favorable. As you can see, the emerging markets are the area with the most profit optimism with 28% of investors saying they’re in a favorable situation. Europe had a sharp decline with only 19% saying it’s favorable. It’s down from near its 16 year high earlier this year. American and Japan are both seen neutrally and the U.K. is seen negatively.

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The chart below makes a potentially interesting point about the repatriation tax holiday. As I have mentioned, lowering the repatriation tax to 10% would likely increase stock buybacks because buybacks increased after the repatriation tax was lowered to 5.25% in 2004. The lower the tax rate, the more money that will come back to America. Some firms may bring back less money because their borrowing costs are far below 10%. The interesting point is that in 2004, those saying they wanted buybacks was near the other options. At the end of the year, buybacks were the number one place investors wanted cash flow to go to. Now, capital return and improving balance sheets are low on the list. Increased capital spending has been the number one place investors want cash flow to go for the past few years. This could mean, the repatriation tax holiday could lead to fewer buybacks as a percentage of capital allocation than last time. However, the counter point to that is firms have bought back a record amount of stocks during this period where capital spending is highlighted as important. Secondly, this poll might change like it did in 2004 after the repatriation holiday was put in place. Maybe investors will want the lump sum that corporations will have access to in cash.

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I often discuss wage growth in the context of the relative slack in the labor market. Another way to measure wages is seen in the chart below. It measures wage rigidity which is the percentage of workers who haven’t had a nominal year over year raise. Not having a nominal raise is a big deal because it is the equivalent to a real pay cut. As you can see, the wage rigidity was the highest in the past 20 years in the early 2010s. To be fair, this chart doesn’t account for inflation changes. What I mean by that is when inflation is low, it’s more likely there won’t be nominal wage growth for some workers. The other noticeable aspect of this chart is that it is starting to show an increase. This doesn’t necessarily imply a recession is coming, but it is bad news for more workers than last year.

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The final chart we’ll look at in this article is the investment grade gross leverage. As you can see, median leverage is at a new record high. The leverage including and excluding energy is similar because the oil market has stabilized. This leverage makes for the possibility that firms will use the repatriated money to pay back the debt on their balance sheets. Some firms have taken out excessive debt to fund buybacks. If interest rates rise, the chickens will come home to roost as this debt will become too expensive to maintain. Even the cash rich Apple has $108 billion in long term debt. I’m not saying Apple will be in trouble, but the era of increases in buybacks could be over. Apple is considered best of breed because of its $260 billion in cash. That’s why I mention it. If Apple faces any constraints, you know the weaker companies will be in a world of hurt.

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Conclusion

The stock market is now in the third biggest bull market ever. That’s why I looked at some situations which show how it can end. Credit growth looks disconcerting and the leverage corporations have taken on is also high. I’m interested to see where the money from the repatriation tax holiday will go. It’s impossible to predict because we don’t know what the rate will be. We will get more information on the tax proposals in the coming weeks. The game theory with Congress will once again play itself out.