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| Posted: 27 May 2020 at 10:50 | IP Logged
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why do so many big American companies look so unstable£¿
Even though a bunch of US economic indicators are looking
good and interest rates are low, half of investment-grade
corporate bonds are just one notch above junk status.This
could be because levered US corporates have used their
debt in ways that aren't productive for the economy and
don't contribute to corporate profitability.That means
that as the economy shows signs of slowing, weak hands
could have a harder time servicing their debt.This is an
opinion column. The thoughts expressed are those of the
author.Visit Business Insider's homepage for more
stories.To get more news about
WikiFX, you can visit
WikiFX news official website.
¡¡¡¡¡°Our economy is the best it's ever been,¡± President
Donald Trump said while touting his administration's
policies during his State of the Union speech this
week.He cited a rising stock market, low unemployment
numbers, and rising wages ¡ª which have yet to compare to
precrisis boom times but are still inching up ¡ª all as
reasons to rejoice.And indeed, consumer confidence, as
measured by The Conference Board, increased to 131.6 in
January from 126.5 in December. It was the survey's
highest reading since August.Unfortunately, this message
of prosperity has clearly not reached America's
corporate-bond market.There, in the space where companies
trade their debt, it appears conditions are
deteriorating. As Scott Minerd, the global chief
investment officer of Guggenheim Investments, said at the
World Economic Forum last month, 50% of the investment-
grade corporate bond market is rated BBB by credit-rating
agencies, a notch above the level where debt is
considered ¡°junk bonds¡± (or as we now say politely on
Wall Street, ¡°speculative grade¡±). In 2007 that number
was 35%.
¡¡¡¡That so many companies are teetering on the edge
worries Minerd, to say the least.¡°We expect 15% to 20%
of BBBs to get downgraded to high yield in the next
downgrade wave: This would equate to $500 [billion] to
$660 billion and be the largest fallen angel volume on
record ¡ª and would also swamp the high-yield market,¡±
he said. ¡°Ultimately, we will reach a tipping point when
investors will awaken to the rising tide of defaults and
downgrades. The timing is hard to predict, but this
reminds me a lot of the lead-up to the 2001 and 2002
recession.¡±But why worry, Minerd£¿ Yes, corporate debt
is high ¡ª nearing $10 trillion and pushing the US to a
record 47% debt-GDP ratio ¡ª but interest rates are low
and don't appear to be going up anytime soon. Plus,
corporations have cash. Under these economic conditions,
you could argue that corporations in need could just
refinance their debt and be fine. It's why some say that
bond bears are overstating the risk here.It's what you do
with itBut there are two problems with this way of
thinking. One is, of course, that rosy financial
conditions will not continue forever. The other is that,
as the folks over at the International Monetary Fund
wrote in their ¡°Global Financial Stability Report¡± last
fall, corporate debt ¡°has risen and is increasingly used
for financial risk-taking ¡ª to fund corporate payouts to
investors, as well as mergers and acquisitions (M&A),
especially in the United States.¡±
¡¡¡¡Put another way, it isn't just that this debt exists;
it's that it's being used in ways that aren't
particularly productive for the overall economy. Balance
sheets are getting loaded up, but companies don't have
much to show for it aside from soaring stock
prices.Despite the magnanimity of Trump's corporate tax
cut, starting last year business investment has been in
its longest slump since 2009. Instead of using cash to
invest in things that would make the economy and their
companies more productive ¡ª like new equipment, better-
trained or paid workers, or research and development ¡ª
corporate America just paid out its shareholders and
itself.In 2018, ¡°the S&P 500 Index did a combined $806
billion in buybacks, about $200 billion more than the
previous record set in 2007,¡± according to the Harvard
Business Review. Goldman Sachs called corporate buybacks
¡°the most dominant source¡± of demand for stocks last
year, while warning that purchases were beginning to
wane.Say what you want about buybacks, but they don't
make the economy or a company more productive. They don't
pave the way to higher corporate profits. Neither do
dividends to shareholders. And it seems this lack of
investment is starting to show in our economy. In the
third quarter of last year, productivity fell for the
first time since 2015. It is a trend that some
economists, such as Ian Sheperdson, the chief economist
at Pantheon Macroeconomics, say is likely to stay with us
for a bit.¡°The year-over-year rate of growth of real
business capex has slowed from a recent peak of 6.9%, in
Q2 2018, to just 0.3% in the fourth quarter of last
year,¡± he wrote in a recent note to clients.
¡¡¡¡¡°A dip below zero, for the first time in five years,
looks almost inevitable in the first quarter, thanks to
the combination of adverse base effects and a near-flat
trend in the quarterly run rate. Against that backdrop,
we are confident that productivity growth will slow this
year, to about 1%. The fourth quarter increase was
probably about 1.6% annualized, but that's just not
sustainable as businesses pull back their spending.¡±A
dangerous cocktailNow, combine high debt levels with a
misallocation of capital and the fact that corporate
profits have been falling for the last two quarters. Sure
stocks are ripping, but according to FactSet companies in
the S&P 500 are projected to report a 2% decline in
fourth quarter earnings from the same time in 2018. That
is why Goldman Sachs said stock buybacks are about to ebb
too.
For companies on the brink of junk (I'm sorry,
¡°speculative grade¡±) status high debt, low productivity
and lower profits are a dangerous cocktail. Taken all
together it could make debt servicing more challenging
for companies in rough shape.For investors it's a
cocktail made all the more dangerous by the fact that
corporate credit spreads have been so tight, lulling them
into a false sense of security as they chase higher
yields.
¡¡¡¡¡°Ultimately, this leads to what he called a Ponzi
Market where the only reason investors keep adding to
risk is the fear that prices will be higher tomorrow (or
in the case of bonds, yields will be lower tomorrow),¡±
Minerd said in Davos.So why are so many companies
teetering on the edge of junk status in a relatively
healthy economy£¿ Consider this: The word credit comes
from the Latin word for trust, and what the corporate
bond market may be telling us is that it can no longer
trust in corporate America's ability to invest
productively, hurting profit generation. It may be
telling us that even in a world of extra low interest
rates eventually debt ¡ª and what you do with it ¡ª
matters.
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