Debt is the issue: While the headlines of Valeant’s negative plunge centered on wrongdoing and price increases resulting from mergers, some short sellers who were critical of the stock looked at the corporate debt load with concern. Once the Valeant machine reached a certain negative revenue to debt point, the debt would subsume the organization, was the thesis.
With this in mind a new CLSA piece is showing that corporate debt as a whole is set to get much larger – as much as 50% larger – and could reach $75 trillion by 2020, up from nearly $50 trillion currently. When compared to estimated GDP growth, the growth in corporate debt is moving at nearly a five times as fast a rate. This presents problems for not only stock, but high yield debt investors and it is not just the US that has the problem.
Debt - Much like society, only the top 1% of corporations are cash rich
There is a perception of the American corporation as the cash-rich uncle who never runs out of money.
The reality is different.
“Corporate America is increasingly indebted and not as cash-rich as widely perceived,” Absolute Return Partners was quoted as saying.
To support their thesis, they back out the top 1% of cash-rich companies – which hold nearly 50% of all corporate cash -- to note that the cash holdings of the 99% are 6% lower than 2015. These companies have $900 billion in cash versus $6.6 trillion in debt. Among US corporates that S&P covers, debt overall has risen 80% since 2007, the CSLA report noted, pointing to a compounding burden.
The five most cash-rich companies are all technical corporations – Apple, Microsoft, Google, Cisco and Oracle – and they control nearly 30% of all the corporate cash.
Debt - Prevailing view that corporate balance sheets are "in very good shape" is challenged
This high debt load has very real consequences. The CLSA report observed that “the prevailing view” is that corporates “are in very good shape” with a significant amount of cash no the balance sheets.
Particularly as it relates to corporate high yield bonds, this makes the investment look “relatively attractive” and “comparatively safe.”
What is happening is that these debt-rich companies are witnessing their assets being questioned, as corporate investments in the US are hitting a 60-year low, the report noted.
At the top of the list is AB InBev, formerly Anheuser Busch, for instance, has a net debt to equity ratio of 247.8 with nearly $92 billion in debt. To provide a stark comparison, Petrobras, like many in the Petro/Chemicals area, has a net debt to equity ratio of 101.3.
With increasingly weaker bond offering credit, a “correction is inevitable,” with a base case pointing to a credit slowdown for several years – called the “slow burn” scenario. But watch out, a series of significant economic or political shocks could create a systemic credit event, what is categorized as a “Crexit” scenario. This type of analysis isn’t very far off from bond market participants such as Doubline Capital’s Jeffrey Gundlach, who has noted the bond market is positioned for a “big, big moment.” The webcast in which he made such bold pronouncements was taken offline for a “compliance review” on Friday.
Central planners look for fiscal help as US is not only corporate region where debt is an issue
As central planners are plowing forward with monetary expansion – and fiscal stimulus is a twinkle in both political and central banker minds – it is not just the US where debt is a growing problem.
In Asia ex-Japan and Australia net debt has been growing with Taiwan the only sovereign country in a net cash position, the report noted. China is a particular issue.
In regards to Japan, strategist Nicholas Smith is one who thinks their central banks are going to press hard for additional negative interest rates until they can squeeze inflation out of the economy – even if it means regional financial stocks will become the “sacrificial lamb.”
“Some of our brokers here in Tokyo have taken the view that because Kuroda today discussed costs to the banking system from QQE+NIRP that therefore Kuroda is considering reversing some of his policies,” Smith was quoted as saying. “I am being asked whether I agree. I absolutely do not.”
Smith is going against those hoping that Japan will experiment with “helicopter money.” This concept uses central bank balance sheets to finance fiscal stimulus and has raised loud voices on both sides of the argument. On one side are those who argue that central bank debt does not matter – or at least not matter to the same degree – as does government debt. They think the central banks, charged with controlling a sovereign nation’s currency, can engage in monetary expansion until inflation is appearing on the economic radar.
On the other side of this argument are those who say the moral hazard of getting central banks involved in financing government debt is a bridge too far. Other voices say that the experiment has catastrophic downside risk if central bank economic planners are wrong.
And still others say there is a demographic shift taking place that will economically impact the developed world in some unwanted ways that will require new thinking.