Is This The Chart That Has High-Yield Investors Running For The Hills?
We discussed the major rotation, overvaluation, and underperformance of high-yield credit markets recently as relevering stock-buying-back firms find their source of funding starting to dry up. The question is - why now? Perhaps this chart of the wall of maturing corporate debt ($3.9 trillion by 2019 which will need massive liquidity to roll-over and will eat earnings thanks to higher coupons) is what triggered the anxiety as the end of QE and start of rate-hikes looms close...
With no QE and a Fed on the verge of raising rates, rolling over $3.9 trillion in corporate debt (at implicitly higher coupons) means trouble for balance sheets and end to easy cheap buyback-funding...
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Remember all that bullshit about pristine corporate balance sheets and cash on the sidelines... well as a gentle reminder we only warned that it was a mirage twenty times as firms added debt while they could... instead of cleaning up, they levered up... debt was not delevered, it was rolled and raised...
Mark Spitznagel's words are clear - scale the cash on the balance sheet against debt and we are as bad as we were in 2008.
US companies are carrying far more net debt than in 2007
Another curiosity is this notion that US companies have substantially reduced their debt pile and are therefore cash rich. The latter is indeed true. Cash and equivalents are at historically high levels, but rarely do those who mention the mountains of corporate cash also discuss the massive increase in debt seen over the last couple of years.
In fact, debt levels have been growing to such an extent that net debt (i.e. excluding the massive cash pile) is 15% higher than it was prior to the financial crisis.
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As we noted previously, this is why 'equity' investors should care
The last few years' gains in stocks have been thanks massively to record amounts of buybacks (juicing EPS and also providing a non-economic bid to the market no matter what happens). This financial engineering - for even the worst of the worst credit - has been enabled by massive inflows into high-yield and leveraged loan funds, lowering funding costs and allowing CFOs to destroy/releverage their firms all in the goal of raising the share price.
Simply put - equity prices cannot rally for long without the support of high-yield credit markets - never have, never will - as they are both 'arbitrageable' bets on the same capital structure. There can be a divergence at the end of a cycle as managers get over their skis with leverage and the high yield credit market decides it has had enough risk-taking... but it only ends with equity and credit weakening together. That is the credit cycle... it cycles.
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US corporates saw profit growth slow to almost zero last year and on an EBIT basis it has been flat for some time now. Earnings quality, rather than improving is actually deteriorating, as indicated by the increasing gap between official and pro-forma EPS numbers. As a consequence, following a long period of overspending and in the absence of a strong pick-up in demand, corporates will have to spend less and not more.
Finally, as a consequence of such anemic growth, corporates have been gearing up their balance sheets in an effort to sustain EPS momentum via the continuing use of share buybacks. With markets up substantially in 2013 executing those share buybacks has become increasingly expensive. Little wonder companies have to borrow so much to continue executing them.
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For those who suggest "running for the hills' is a little strong, yes we know a 35bps correction is 'not much' but from a sub-300bps HY spread perspective it is the biggest 3 week swing in 13 months (since the Taper tantrum) and outflows are the biggest in years...
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