As we noted yesterday [7], the credit bubble is in full swing as high-yield covenant protections hit a new low in January. At the same time, new issue premia in high yield credit has remained extremely low (meaning demand is high) - even as leverage (measured in a number of ways) surges to post-financial-crisis highs. With low yields and technical demand so abundant, firms appear to be leveraging-up in favor of shareholders. But, as is always the case, there is a limit to just how much leverage can be piled on before credit spreads 'snap' and raise the cost of capital - hindering the equity price. Finally, for the 'cash on the balance sheet' advocates, US firms' Cash/Debt is its lowest (worst) since pre-crisis. Banks continue to delever, sovereigns relever, and non-financials taking their lead - this didn't end well last time... and this time, exuberance and positioning is very heavy.
Investment Grade Leverage in the US is rising rapidly - but its the sovereigns that are leading the post-crisis releveraging...
[8]
And High-Yield leverage is also surging... and for all those 'cash on the sidelines' hopers, Cash/Debt is now at its lowest (worst) since before the crisis...
[9]
as Global banks slowly but surely delever...
[10]
Though demand remains high for bond issuance...
But where is all that leverage going? Straight to the shareholders...
But those shareholders better hope that nothing goes wrong - as they are all in complacent...
and we have seen these 'releveragings' try and drag stocks higher before - with disconnects between HY credit (being priced for that higher leverage) and stocks...
[11]
but soon enough the realization comes as credit traders shift from picking winners to avoiding losers...
The credit cycle is called a cycle for a reason - and now firms are in the releveraging mode, that systemic demand for credit may just become a little more idiosyncratic and remove a leg from the equity market's stool of exuberance.
Charts: Bloomberg and Morgan Stanley