Have I committed a chart crime? It’s possible, but perhaps not, in either case I’ll put myself at the mercy of readers.
What I’m referring to is a chart and tagline I tweeted out a few days ago that has stirred a bit of debate and discussion and I welcome the debate as it pertains to a larger issue: Corporate debt.
Here’s the tweet in question:
My impression from some of the critical comments was that I seemed to imply that $GE’s fate is a predictor of what will happen to $SPX. Clearly $GE ran into trouble well before markets peaked this time around and hence one can certainly argue that any comparison is off base.
The fine folks at Alphaville via the Financial Times had the following to say about the tweet:
I take their latter comment on board and agree with it: Companies come and go and any individual company can run into problems and that may not be predictive for the entire market.
But I note, they are also hedging their bet a bit: “It probably is different this time”.
Let me clarify as to why I posted the chart in the first place, and that is to highlight a larger point: Easy money has permitted companies to take on more debt than ever before and that all works as long as money remains cheap and your business model generates enough growth to sustain the debt. If a company runs into operational issues and slowing growth while rates are rising the gap becomes rather prohibitively quickly as we now see in $GE.
And debt has been taken on across America’s corporate sector for all kinds of reasons, operational, pensions, buybacks you name it. But not only has the absolute amount of debt ballooned, the quality of the debt has sunk.
Indeed BBB is now the biggest driver of all of this:
Yes there’s a reason that chart has the phrase “Bid Downgrade” on top of it. Moody’s recently downgraded junk debt:
“Baa 3-grade corporate debt outstanding reached an “unprecedented” 56.8% of speculative-grade, or “junk,” high-yield corporate bonds outstanding. By comparison, the ratio of outstanding Baa 3-rated bonds to high-yield bonds was 32.5% before the 2008-2009 financial crisis, 36.9% before the 2001 recession and 22.2% before the 1990-1991 downturn.
“All else the same, investment-grade bonds rated Baa 3 are at the greatest risk of incurring a fallen-angel downgrade,” John Lonski, chief economist at Moody’s Capital Markets Research wrote in a note to clients. “Fallen angel” refers to a bond that is downgraded to junk from investment-grade.
“Thus, from the perspective of dollar amounts outstanding, the U.S. investment-grade corporate-bond market is now riskier than it was before each recession since 1981 and possibly all prior downturns through the late 1940s,” Lonski said.”
And markets are reacting:
Jeffrey Gundlach recently also opined on all this:
“Stay out of investment grade bonds,” Gundlach said. “Because when rates start to rise in earnest, God forbid you get a downgrade. It’s amazing how people have been copacetic about the credit situation.”
And the worries are well justified, after all corporate debt has doubled since 2007:
“Over the past decade, companies have taken advantage of low rates both to grow their businesses and reward shareholders.
Total corporate debt has swelled from nearly $4.9 trillion in 2007 as the Great Recession was just starting to break out to nearly $9.1 trillion halfway through 2018, quietly surging 86 percent, according to Securities Industry and Financial Markets Association data. Other than a few hiccups and some fairly substantial turbulence in the energy sector in late-2015 and 2016, the market has performed well”.
The hope is that the hiccups, i.e. $GE, remain the exception.
But please everybody, this all works only if rates remain low and growth continues to expand. If you have not noticed there’s a global growth slowdown going on and fancy valuations, as we’ve also recently seen, can disappear very quickly:
Hence it is no wonder we have a non ending parade of people urging the Fed to stop its rate hike cycle now (see The Fed Crying has begun).
So have I committed a chart crime? If the result is that the Fed caves and remains at real negative rates or stops at neutral and then pauses perhaps the timing can be extended and the hiccups can remain just that.
And it must be a dovish Fed again to make it all possible as magical expanding growth is not going to bail out the debt laden corporate sector.
That ship has already sailed:
So best hope the Fed caves as everybody wants it to do. At real negative rates still.
Otherwise that example that $GE is setting is not a hiccup or outlier, but a harbinger of things to come.
And don’t think $GE’s debt problems are not impacting anybody else. Other’s have exposure to GE’s problems:
As I stated in the original tweet: Better hope it’s different this time.
And on that note: Happy Thanksgiving to everyone in the US. 😉