The major indices shrugged off a multitude of risks and rose sharply today, extending yesterday’s powerful rally, as reports surfaced of apparent progress in trade talks between the U.S. and China.

However, in homage to the legendary rhythm and blues artist Aretha Franklin, who died yesterday at the age of 76, I want to emphasize the word r-e-s-p-e-c-t, as in giving investment risks the respect they deserve.

I was a teenager when Franklin was topping the charts with iconic songs such as Respect. My youth was reckless. As a teen driver, I racked up a lot of speeding tickets, auto repair bills, and property damage. I’m much wiser now (as well as lucky to be alive).

During this bull market, have you been reckless? If so, you face a collision with reality. Below, I outline the major risks that demand respect. First, let’s look at Friday’s market action.

The Dow Jones Industrial Average, S&P 500 and Nasdaq all closed in the green today, as investors were cheered by easing trade tensions between the world’s two largest economies.

Investors also were encouraged by the continuing strength of second-quarter corporate earnings. Bellwether stocks surprised on the upside (see Big Gainers below).

Walmart’s (NYSE: WMT) operating results crushed expectations yesterday, showing that legacy retailers are successfully taking the fight to e-commerce. The retail giant’s stellar report card was a major catalyst for Thursday’s upswing.

The risks ahead…

“Ooo, your kisses
Sweeter than honey
And guess what?
So is my money…”

As any blues singer will tell you, there’s always something to worry about. The Turkish lira resumed its downward trajectory today, as tensions between the U.S. and Turkey persisted.

Disappointing guidance from key chipmakers today kept the technology sector’s gains in check. The tech-heavy Nasdaq spent most of the day in the red before recovering in the final minutes of trading. A sputtering semiconductor industry would signal a slowing overall economy and a loss of momentum for the technology stocks that have disproportionately propelled the bull market.

A harsh spotlight fell on Nvidia (NSDQ: NVDA). The maker of ultra-sophisticated chips said it expects to post $3.25 billion in revenue in the fiscal third quarter, versus the $3.34 billion expected by analysts. NVDA shares today fell 4.90%, weighing on its peers and ancillary sectors (see Big Decliners below).

Another red flag is falling consumer sentiment. The University of Michigan reported today that its consumer sentiment index in August fell to 95.3, down from 97.9 in July, the lowest level in 11 months.

Other salient concerns include excessive stock valuations, tightening monetary policy, and rising inflation.

Inflation has climbed in 2018 to a year-over-year pace of 2.9% after ending 2017 at 2.1% (see chart, compiled with data from the Bureau of Labor Statistics):

Hotter than expected inflation would prompt the Federal Reserve to hike rates more aggressively than planned, a scenario that would hurt stocks.

Tick tick tick…

One threat that gets scant coverage by the media is the fast growth of low-grade corporate debt. It’s a time bomb ready to explode.

During the era of ultra-low interest rates that followed the Great Recession, corporations loaded up on debt. But instead of using that money to invest in organic growth, most of these borrowers launched share buyback programs or funded mergers.

What’s more, interest costs are tax-deductible, which means Uncle Sam has been subsidizing corporate American’s debt spree. The stigma of lower-grade debt has diminished over the past 10 years, echoing the go-go 1980s when Gordon Gekko-type corporate raiders used junk bonds to finance leveraged buyouts. The crash of 1987 ensued.

Since the 2008-2009 financial crisis, corporate-debt issuance has boomed. Because of the Federal Reserve’s quantitative easing, government bonds have sported low yields, prompting investors to seek higher yields via ever-riskier bonds. Companies have exploited this demand.

The confluence of these trends has resulted in a preponderance of BBB-rated debt (see chart, compiled with data from Standard & Poor’s):

There’s currently $3 trillion in outstanding U.S. debt rated triple-B, up from $1.3 trillion five years ago and $686 billion a decade ago. That’s the most ever for companies rated triple-B.

Triple-B debt securities are the lowest-quality debt that qualifies for investment-grade status. A downgrade to double-B pushes a company’s bonds into high-yield junk territory. Now that rates are rising and a recession looms around the corner, many of these highly leveraged firms could fall victim to a wave of downgrades and defaults.

To all of the above risks, pay respect. More than a little bit.

Friday Market Wrap

• DJIA: 25,669.32 +110.59 (0.43%)
  
• S&P 500: 2,850.13 +9.44 (0.33%)
  
• Nasdaq: 7,816.33 +9.81 (0.13%)

Friday’s Big Gainers

• Zoe’s Kitchen (NYSE: ZOES) +33.26%

Restaurant chain agrees to acquisition.

• Nordstrom (NYSE: JWN) +13.27%

Department store chain beats on earnings.

• Frontline (NYSE: FRO) +11.20%

Seaborne energy transporter announces equity offering.

Friday’s Big Decliners

• Zion Oil & Gas (NSDQ: ZN) -27.13%

Energy producer’s drilling prospects deteriorate.

• Amyris (NSDQ: AMRS) -12.60%

Industrial biotech announces secondary offering.

• Applied Materials (NSDQ: AMAT) -7.72%

Supplier to chipmakers issues weak guidance.

Letters to the Editor

“As Trump talks about creating a so-called Space Force, I wonder whether satellite companies are good investments.” — Darrell D.

Investors tend to focus on commercial or military aviation as opposed to the satellite industry. However, the accelerating commercialization of outer space for navigation and telecommunications should confer outsized growth on the companies that develop, build and operate satellites.

Need advice on risk management? Drop me a line: mailbag@investingdaily.com

John Persinos is the managing editor of Investing Daily.