Great article. The world’s central banks have created another huge bubble that is in the process of bursting. So many people, including the IMF, have highlighted the issue. Mom and Pop are going to be mightily pissed when their ‘safe’ investment grade Corporate bond fund blows up t.co/QQvWeCfTg7
— Albert Edwards (@albertedwards99) November 8, 2019
Stats tell the story of deterioration:
- The third quarter of this year saw the most credit rating downgrades for U.S. companies relative to upgrades since 2015, according to Bloomberg.
- Over the past 12 months, non-financial S&P 500 cash balances have declined by $185 billion, or 11%, the largest percentage decline since at least 1980, according to a Goldman Sachs analysis.
- Excluding financial companies, leverage — how much debt a company owes relative to earnings — hit an all-time high in 2Q19based on investment-grade bond data going back to 2004, according to JPMorgan Chase.
- Leveraged loans totaling more than $40 billion and tied to more than 50 companies are in the midst of a “meltdown”, with lenders “lucky to get back just two-thirds of their investment,” according to a Bloombergreport last week.
Despite these signs of weakness, companies continue to flood the market with new supply. Firms in the S&P 500 have increased debt burdens by 9% so far this year, or $410 billion. And globally, “September was the busiest month ever for corporate debt issuance,” with a record $434 billion in bonds sold, according to The Financial Times.
Yield-starved investors have met that supply with demand. More than $160 billion has flowed into investment-grade bond funds so far this year, roughly $60 billion more than in all of 2018. And as the WSJreported last week: “This year’s 13% gain in [U.S.] corporate bonds is more than twice the 6.1% average since 2009.” Corporate debt complacency is also clear in equity markets. As Bloomberg reported late last month: “For the first time since 2016, companies with fragile balance sheets are outperforming…The outperformance is so stark that a pure measure of leverage is the top equity factor this year among 10 styles tracked by Bloomberg.”
For more than a year, we have warned about the threat that record corporate debt poses to global financial stability. Now, with global growth slowing and CEO confidence retreating, the question becomes: How vulnerable are bond and equity markets to a simultaneous spike in defaults, ratings downgrades, and corporate belt tightening?
While a GFC-level crisis may be unlikely, corporate debt today has troubling parallels to last decade’s mortgage bubble, from liquidity-challenged financial engineering to apparent collusion between debt sellers and ratings agencies. Just last week, the IMF warned that as much as $19 trillion in global corporate debt — or roughly 40% of borrowings by companies in the U.S., China, and some European economies — are at risk of default in the event of a severe economic slowdown. “The risk is that losses could cascade through the banking and non-banking financial sectors, amplifying the shock of any downturn,” wrote the IMF.
On Sunday, The Wall Street Journal published an article with troubling implications: “Bond Ratings Firms Go Easy on Some Heavily Indebted Companies.” The amount of debt rated triple-B — one rung above junk — has tripled over the past decade to $3.7 trillion, or roughly 50% of all investment-grade debt. There’s clearly skepticism about the credibility of many of those BBB ratings: roughly $100 billion of BBB bonds currently trade with yields like junk.
The story of Newell Brands provides a vivid example of why that skepticism is merited. First, Newell was allowed to keep its investment-grade rating despite piling on debt to acquire Jarden Corp. for $20 billion in 2015. A provision tucked in Newell’s acquisition bond sale would have required the company to pay investors $160 million in annual interest costs if it got downgraded to junk. As The WSJ writes: “The provision highlights the conflict faced by the ratings firms. Investors use rating firms’ research, but companies that issue bonds pay for the ratings.”