The issuance of corporate debt in the United States is expanding at an alarming rate, if investors consider the mediocre economic growth that has been the rule since the end of the Great Recession in June 2009. In 2015 it is growing faster than at any other time. This is on top of three record breaking years of additional debt. Much of this financial activity is being funded by the excessively low rates of interest, that were put in place by the Federal Reserve Bank beginning in 2008.
Although it is true that many firms in the United States have profit margins that are also near their record levels, the pile on of debt is worrisome if an investor believes that we are nearing the end of the boom in the American Stock Market and economic recovery. Therefore, these loans will later need to be repaid in an era of declining revenues and economic fortunes.
Rising corporate leverage is troubling, if one does a comparison to the last time the value of assets collapsed in the face of a financial panic and the resulting dramatic economic downturn. The sudden fall of Lehman Brothers in New York in the second half of 2008 exposed the reality of over exposure of debt in the markets.
Banks were particularly hard hit as the contagion spread to Asia, Europe and Latin America. It resulted in massive government bailouts of the financial institutions and a virtual collapse of the mortgage markets particularly in the United States. Over extended borrowers were also forced to sell assets at vast discounts which helped amplify the price decline in various sectors across the economy.
Corporate debt in the United States has jumped from $568 billion USD (United States Dollar) for the first four months in 2014 to $609 billion USD this year. It is beginning to create a major headwind for future growth, as more of the future revenues for businesses will be allocated towards debt servicing and repayment.
Yet, many investors are buying this new issuance of debt in a market where government bonds have dropped to just 2% in the United States and near zero in Europe and Japan. The central bank policies of the developed world are fueling this accumulation of debt, by following policies of historically low interest rates and quantitative easing. In the United States the third round of purchasing mortgage backed securities and government debt ended in October 2014. However in Europe, the ECB (European Central Bank) it is just beginning a new round of quantitative easing and in Japan there is a doubling down of such policies by the central bank there.
Lower rated bond known as junk bonds are also selling at an accelerated pace. This is debt issued by companies that are rated double B plus or below. It is a warning sign of what is to come once the economy slows even further and tips into recession. Then defaults will rapidly become quite likely. At the present time the default rate is less than 2% as compared to 15% during the last recession.
The accumulation of household debt, including credit cards and student loans is also moving up, approaching levels that are just under 7% short of the highs, last witnessed in the time right before the financial panic in 2008. As the percentage gets ever closer to the previous high, it indicates that consumers alone, will not be able to keep the economy expanding as more market forces turn negative.
In the stock market itself, borrowing is now at the highest level on record in the last 50 years. In March the margin debt hit $476 billion USD. This indicates that investors expect stocks to continue their climb past 18,000 on the New York Exchange. That records are being set across the board only heightens the expectations of future gains. In April for example, the NASDAQ finally beat the previous high last seen in the year 2000, at the end of the stock boom associated with technology sector. The Standard and Poor 500 has already experienced 6 record closes this year, with more anticipated this summer. The Dow Jones Industrial Average (DJIA) itself, has broken 4 records so far this year. This cannot continue indefinitely.
At the end of the 1st business quarter in March, 184 United States companies carried ratings of B3 with a negative outlook up from 146 in 2013. The number keeps rising in the present expansive market. It can be expected that these will be the first companies to default and go into bankruptcy, when the bull stock market finally ends.
The rapid rise in debt by many of these companies might be a good thing if the money was being used to finance new equipment and technical upgrades or at least to fund an expansion in operations. Then at least an expected future income boost would negate the cost of the loan. However, this has not been the case in the market today. The only thing actually being spent at dismaying rates, is the equity in the corporations themselves.
What the money is being used for today is financing countless stock buybacks, leveraged buy outs, and mergers that are not actually increasing the future output and productivity of the companies themselves. Although some corporate acquisitions in different sectors do make sense, the wholesale rush that is now occurring, will return very little to the bottom line when the new debt is factored into the equation. During the month of February alone for example, stock buybacks for the Standard and Poor 500 were at a record $104 billion USD.
The reality is that total corporate debt and business debt which stood at $11 trillion USD in late 2007 has now ballooned to $14 trillion USD. So despite the business pundit rhetoric about corporate deleveraging having taken place since the last debt crisis the numbers indicate otherwise.
Real net investment in the productivity of businesses in the United States is now 25% less than it was before the advent of the last recession in December of 2007. All the money printing, low interest rates, and the explosion in corporate debt is not really creating sustainable growth in the economy. Productive capacity in the United States is in serious decline and this will have disastrous long term effects for the economy overall.