Barron’s has published an interesting article which argues that there are ten asset bubbles waiting to pop in markets. According to an analyst cited in the publication, further coordinated global central bank easing is likely to exacerbate these bubbles and turn a “run-of-the-mill recession into a full blown financial crisis”. The ten asset bubbles cited are in the following asset classes: US government debt, US corporate debt, US leveraged loans, European debt, Bank of Japan Balance sheet and related equity holdings, unprofitable IPOs, crypto and cannabis, growth and momentum stocks, software and cloud stocks, ETFs (especially fixed income).
FINSUM: So the whole world is in a bubble except the asset class that most people pay the most attention to—US stocks. The thing about many of these “bubbles” is that the economy is still plenty healthy to cover them (such as companies’ ability to cover interest etc).
There has been growing consternation about the threat of a major meltdown in corporate debt. The Fed, in particular, has been very troubled by the amount of corporate debt in the economy, which has led to speculation by Wall Street that there could be a blow up. Goldman Sachs has been more sanguine, saying debt levels look healthy. Now the Fed appears to be taking a more mild view as well. In a speech this week, Chairman Powell said that the comparison to pre-Crisis debt levels are not convincing. “Most importantly, the financial system today appears strong enough to handle potential business-sector losses, which was manifestly not the case a decade ago with subprime mortgages.
FINSUM: Debt levels seems high, but profits are margins are good to. The question is what happens when the economy turns south. We are especially concerned about the BBB market.
There are currently a lot of fears about corporate credit’s ability to sink the economy and markets. There has been an absolute massive surge in issuance since the Financial Crisis, and a great deal of that issuance happened in credits just on the bottom fringe of investment grade. And while a good amount of that debt may founder and sink into junk, it won’t be enough to hurt the economy much. The reason? It is because US households have not increased their leverage significantly in recent years, which is likely to prove a saving grace for the economy. Growth in household debt has been lower than inflation, a sign of relative health.
FINSUM: While corporate credit can get markets in trouble, so long as the American consumer is not deleveraging, things will probably not get too bad in the wider economy.
The next recession has been talked about seriously for the last year or so, and discussion of it is rising now. But what might actually trigger the next downturn? The New York Times sees three possible triggers. The first is the Fed playing the economy wrong and sending the the country into a recession by being overly aggressive with rate hikes. In this scenario, 2020 seems like the doom year. Then there is the risk of the debt bubble bursting (just like the last recession), this time in corporate debt, which has seen a huge surge in issuance since the Crisis. Finally, the looming trade war could drive the whole global economy downward, sparking a major recession.
FINSUM: The corporate debt bubble bursting is a good insight, but much less discussed than the others. It is also interesting because it would be highly linked to the Fed. Maybe that is the double whammy?
Investors need to be worried about the amount of corporate debt out there. Over the last decade, companies have binged on corporate debt to the tune of $14 tn of issuance. Total US corporate debt from nonfinancial companies is now 74% of GDP, its highest ever. And total corporate leverage is now 20% higher than before the Crisis. On the back of this, Goldman Sachs says that so far this year stocks with the strongest balance sheets have been outperforming weaker ones considerably. Here are some companies to look at to protect one’s portfolio from a crunch: Mastercard, Electronic Arts, Equity Commonwealth (a REIT), Graco, and Verizon.
FINSUM: The amount of corporate debt is quite alarming, and it does seem like there will be a reckoning. But when? As long as earnings stay strong, it seems unlikely there will be a big blow up.