Surging Corporate Debt Could Soon Hit $10 TRILLION
Francois Trahan, a strategist at UBS, has seen U.S. corporate debt increasing by more than 50% this past decade, standing now at nearly $10 trillion.
Such concerns could steal the show in 2020, he says. The slowing economic activity and a potential decline in corporate earnings could lead to debt downgrades for brands such as Amazon, 3M, and Walmart.
This surge in corporate debt over the past decade could weight down stocks in 2020. Corporate earnings are slowing to a crawl, and hurting the ability of companies to timely repay that debt and maintain solid credit ratings enabling them to borrow, as Trahan outlines.
Trahan says that credit issues don’t matter in equity market until the economy is slowing or in a contracting phase, as reported by CNBC.
According to Trahan, the U.S. corporate debt has increased by 50% since 2009. At nearly $10 trillion, the corporate debt would be a larger story were it not for a backdrop of a period of economic growth and a drop in yield prices. Yields on Baa-rated corporate bonds have fallen to about 3.9% from more than 6.3%.
If economic activity slows and corporate earnings drop, debt downgrades could be on the horizon, and even for some of the largest companies out there, like Amazon, 3M, and Walmart.
The companies could have to roll over their debt downgrades, half of which is on schedule to mature in the next five-to-six years. This would put pressure on company shares and the broader stock market.
“Leaving aside our biases for markets and the economy, LEIs of credit markets point to a deterioration of ratings throughout 2020,” Trahan said.
The Institute for Supply Management’s new orders index as a key leading indicator, noting it has been in a downtrend for about six months. He notes the index has been below 50 in the past four months. The reading below 50 means there is a contraction.
Trahan notes that this decline in new orders could foreshadow a drop in the S&P 500’s average credit rating, increasing a year-over-year basis. Trahan notes that measure of economic activity leads the stock benchmark’s average credit rating by six months.
“Moreover, interest rates argue that this decline in the ISM is not likely over, suggesting that this risk could possibly last throughout all of 2020,” the strategist said.
Rates fell throughout 2019 as the Federal Reserve pivoted away from the hiking cycle started during the year before. The central bank cut the U.S. overnight rate three times this year after four rate hikes in 2018. Earning expectations are essentially flat, according to Trahan, and should expectations go south, debt downgrades could his markets like a tidal wave.
Trahan noted Amazon, 3M and Walmart are among the S&P 500 companies that are at risk of receiving a debt downgrade in 2020. The strategist’s model that accounts for company size, short and long-term capital turnover, profit margins and long-term liquidity.
Based on that model, Amazon could see its S&P credit rating to BB, the highest junk-bond grade from AA. 3M could see its credit rating fall from AA to BBB along with Walmart.