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It was June 2007 and I was a wide-eyed 19 year old summer intern working in Toronto at GE Commercial Finance*. In hindsight, the world was also naive at the time thinking that a slowdown in the mortgage market would only last 6 months. Fast forward to Spring 2010 when I just joined the Syndicated and Leveraged Finance team at J.P. Morgan New York — the department was on a hiring spree after having restructured and let go more than two-thirds of its talent over the previous three years.

Supply and demand for debt financing (also known as ‘lending’, ‘leverage’ or ‘credit investing’) is a leading and often very accurate indicator of an impending economic recession and market recovery.

If you think about our global economy — government, businesses, investors, consumers — it is all operating off levered capital. And the only way the world keeps running is if growth continues so that its participants can pay back the cost of other participants’ borrowed money with cash. When future growth becomes cheaper than near-term cash (or liquidity) than the markets have become distorted. The ‘food chain’ of the financial world is out of whack.

This started happening in 2018. I noticed that venture and growth debt were priced more expensive and being out-competed by venture and growth equity (see unpopular prediction). In October 2018, Ray Dalio, founder and co-CIO of successful hedge fund Bridgewater, published his Principles For Navigating Big Debt Crises (free PDF; highly recommend reading) predicting a downturn in the next 2–3 years.

Debt should always be cheaper than equity, when structured correctly. The reason being goes back to fundamental finance and economic theory — a concept known as Capital Asset Pricing Model (or ‘CAPM’) which measures the relative reward-to-risk ratio of an asset. Debt is lower risk relative to equity because it ‘sits senior’ — it is paid before — equity shareholders in an exit, and it receives pay back on borrowed money sooner and more frequently than equity (due to shorter holding period and overall structure). In other words, debt is effectively structured equity with liquidity, downside protection, and limited upside.

So why does this matter?

When the activity of lenders and debt markets start picking up again in a big way, we will know our global economy is on its way to a full recovery. Right now, we still live in an world of uncertainty (see VIX index below – above 20 the IPO market is closed) and major industries such as oil—which generates $86TN or 4% of global GDP—are firefighting and restructuring massive debt to avoid a complete collapse (read thisthis, and this article).

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