Don't Look Now, but Credit Is Also Setting Records
With the equity markets continuing their upward climb, many investors have been focusing their attention toward equity valuations when determining whether or not the bull market will end. And that approach does make sense. After all, investors will only pay so much for stocks and be willing to overlook sky-high prices for so long before they take profits.
But that might not be the 100% right place to be looking.
What they should be doing is looking at credit trends. Credit – and the availability of cheap credit – has been one of the biggest drivers of stock and economic gains. And according to investment bank State Street, credit conditions are still pretty rosy.
Will equities continue their run? If history is any guide, they will.
Look Toward Lending
If you've been in the market since the end of the recession, you have to be smiling. Since hitting the bottom, the SPDR S&P 500 ETF (SPY) has increased by more than 275% at this point and continues to hit record highs. However, recently investors have been smiling a bit less. Concerns about the latter stage of the business cycle and the overall expensiveness of equities has made some investors very nervous indeed. That shows up in the increased volatility of the last few months.
And while the Republican tax plan did 'reset' valuations a bit lower – going from a P/E of about 22 to about 16 on the S&P 500 – there is still the idea that we could be coming closer to the end of the bull market and recovery any time now.
Learn more about the tax plan and its benefits here.
But the answer to that question might not lie within equity valuations, but in borrowing and lending companies/consumers money.
Credit has long been a bigger and better predictor of just what will happen to stocks and economy as a whole. The Great Recession didn't happen because valuations were high; it happened because lending activity stopped. And we can see by the Dotcom Boom that stocks can get very expensive indeed before there are any adverse effects.
Credit is so powerful as a tool that the yield curve – or the difference in yields between short- and long-term bonds – has correctly predicted each of the past seven recessions since 1968. And while the yield curve has been flattening since 2016 and is currently the flattest it's been since 2007, several trends are in place to continue keeping the credit cycle going for quite some time. If credit is truly the better predictor of stock and economic gains, then according to State Street we still have plenty of time on the stock market shot-clock.
Still Plenty of Credit to Go Around
It's true that the Federal Reserve has been raising rates and that's causing the flattening of the yield curve. However, the key for equity investors is that the recent jumps in benchmark rates have been slow and steady. This creates more of a 'slow-burn' for investors rather than a full-on roaring bonfire. Inflation remains tame and under control, so there's no reason to turn up the heat.
For firms, this creates an interesting phenomenon. Slow ticks in benchmark rates are easy to handle and companies have been able to handle them well.
Looking at the data, State Street shows that firms have used the low interest rate environment to kick out the maturity profile on their bonds/loans. They've managed to lock in loans, at low rates, for a long time. This simply reduces the effects of rising interest rates. Who cares if rates rise, when you won't need to refinance a loan for more than a decade?
At the same time, lending activity continues to be brisk. Thanks to regulations, banks have stepped back from lending to small and mid-sized businesses. The private sector has come to the rescue and the issuance of leveraged/floating rate loans has surged. However, because of the low rate environment, more and more investors have been searching for yield and that's created a glut of lending activity. Firms are basically competing to issue loans. This has resulted in relaxed covenants and still lower coupon payments for businesses.
All of this has shown up in lower high-yield credit spreads. Firms are able to get the credit they need and at rates slightly above treasuries. Coupling it with the continued confidence in the economy creates a very robust lending/credit environment. You can see by the following chart how all of these factors come into play and how we are not near the conditions we were during the last two recessions.
Source: State StreetUse the Dividend Screener to find high-quality value dividend stocks based upon 16 parameters. For instance, you can create a list like this by selecting stocks with a high Dividend Uptrend DARS Metric and download this screener result on a searchable spreadsheet to perform custom analysis. Stocks with the highest DARS ratings are Dividend.com's current recommendations to investors.
Still Room for Equities to Run
For investors, the ease of access and still low rates means that equities could still see further gains down the road. State Street estimates that economic and credit indicators suggest that stocks could have another 18 to 24 months to run before we see some serious side effects to rising rates. That's a very long runway indeed.
This is particularly interesting for dividend investors. Still low rates are net positives for dividend stocks as investors will favor them over bonds to get their yield fix. And if firms are able to continue reducing their borrowing costs or lock in cheap loans, this will enhance their cash flows further. There won't be as much deterioration to them as rates rise. That could make dividend stocks or funds like the iShares Core Dividend Growth ETF (DGRO) quite lucrative over the next year or so.
The Bottom Line
Credit is perhaps the biggest predictor of the stock market and, right now, things are still pretty rosy for the current cycle. Despite hitting a record for length, State Street sees the current cycle lasting longer as credit remains cheap and plentiful. That will help push stock valuations and prices higher over the next year or so. Investors might not want to give up on their dividend stocks just yet.
Be sure to check out Dividend.com's News section for next week's Market Wrap and other great dividend investing news.
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