Something Wicked (September-October Market) This Way Comes

Aug.29.10 | About: ProShares UltraShort (SDS)

The post Labor Day period brings back-to-school, cooler weather, and economic trainwrecks. This year may be no different.

Here is the Debt to Net Worth for non-financial corporations on line 47 of the B.102 Fed Reserve National Balance Sheet. It will be interesting to see the Q2 data when it comes out in a couple weeks (in percent %):

The Debt to Net Worth for non-corporations (sole propietorships and LLCs) on B103 shows the same trend (in percent %):

This shows that debt is increasing as a percent of net worth (with the high though at the economic bottom in 09-Q1). Since Cash only accrues to the benefit of a shareholder if it is covered by the corporate "net worth" (Assets less liabilities), this is a negative trend. I suspect the trend will continue upwards as we slip into another period of "no-growth" or perhaps recession.

Most of what looks like growing corporate earnings and cash on the balance sheet (ending up as retained earnings and net worth) is an illusion caused by QE and other govt stimulus as it flows through to companies' income statements and then balance sheets. The govt borrows money that QE raises (Treasury sells debt securities to fund stimulus and the Fed buys them) and then transfers the proceeds into the private sector via large corporate incentives (ITC, infrastructure projects, etc) and direct transfer payments (state and muni transfers that get spent on local govt capital projects and payroll, unemployment comp, etc). But the national debt remains, as the aggregate numbers show.

Here is the net effect of those transfers which show the ballooning Federal debt in trillions (does not include long term entitlement liabilities like Medicare and Social Security, but only current credit instruments):

This increasing national debt was an acceptable trade off if it quickly jump started the economy and the cash infusions that flowed through to business balance sheets expanded production and added employees, lowering unemployment (and thereby increasing tax receipts to pay off the debt to fuel the jump start). But this has not happened. Instead, debt grows in both the private and public sector and creates future liabilities that will need to be paid down at the expense of capital investment and consumption. (See here - pdf.)

This growing debt will eventually result in a substantial economic contraction as "austerity" is forced on the American people as it has on Europe. If the Repubs win in November as they most likely will, I think this retrenchment happens sooner than later. The market may be discounting that probability as of today. Buy SDS

Disclosure: I am long SDS (short the market) in several accounts