Thread by @patrick_oshag

1/ Thoughts and questions on debt...

We screen to avoid companies with worrisome leverage and over-reliance on capital markets, so @Jesse_Livermore and I have been discussing the current state of corporate debt. We see lots of worrisome looking charts like this:

@Jesse_Livermore 2/ But these measures leave out a key source of income for U.S. corporations: income from foreign operations, which has grown dramatically over the past twenty years. When we compare debt to measures of sales and income that include foreign sources, we get:

@Jesse_Livermore 3/ We can confirm this observation (which we built from the bottom up using company level data) by comparing the aggregate debt of U.S. non-financial corporations to their aggregate net worth (equity), a measure that more accurately reflects their total paying power:

@Jesse_Livermore 4/ To the extent that corporate debt represents a risk, the risk doesn't appear to be in the amount of debt in the corporate sector per se. Rather, the risk seems more likely to be in the amount of low-quality debt in the corporate sector (curious for other opinions here...)

@Jesse_Livermore 5/ If we enter a recession in the near term, and that debt gets downgraded in response to the stress, a large supply of high-yield debt could be thrust onto the high-yield market at an inopportune time.

@Jesse_Livermore 6/ For value investors, this may all be most relevant for companies which are cheap based on the book/price ratio, because these companies tend to have higher debt levels. The chart below compares debt levels for the cheapest quintile of stocks for book/price and earnings/price.

@Jesse_Livermore 7/ Given the difference in debt levels, negative activity in debt markets, which tends to occur during recessions, may dis-proportionally affect book/price based value strategies.

@Jesse_Livermore 8/ This final chart offers a performance comparison of these two value strategies (e/p and b/p) during past recessions. The sample size is small, but earnings/price has been the superior way of positioning a value portfolio during past recessions.