Why Corporate America is in trouble

Sep 10, 2015

- By Bill Bonner

Bill Bonner
Gualfin, Argentina

Dear Diary,

Dow down 239 points yesterday, after Japan posted a huge move to the upside.

This is getting interesting again. If it is just "volatility" as the Wall Street shills maintain, it will probably pass soon. Everything will be okay. Back to routine imbecility before the end of the month.

But if these whipsaw movements are announcing a real bear market, stock prices could be cut in half....or more...and not recover for 10 to 20 years.

Which is it? No one knows. But the danger is most apparent on the downside. At least now.

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In fact, it looks to us like the whole shebang is getting ready to collapse. So far, $12.5 trillion has been trimmed from equity prices worldwide. But there are few reasons for stocks to go back up...and a lot of reasons why they might want to go down further.

The crisis of '08-'09 was centered on mortgage debt. There was too much of it that couldn't be repaid. Today, consumers have about the same amount of debt, but now the excesses are in auto loans and student debt. Give it a little time; both will probably go bad in a major way.

But today, we're going to look at corporate debt. While households have about the same amount of debt that they had in '07, corporations have far more. Corporate cronies have been taking advantage of low rates to borrow money, buy their own shares, and pay themselves bonuses because the shares go up in price.

That scam is about to come to an end. The Financial Times reports:

    With a $4tn mountain of debt maturing over the next five years, corporate America's reliance on cheap cash is about to get tested.

    US corporate treasurers have rushed to lock in cheap borrowing costs in advance of the expected rate rise, refinancing more than $1tn each year between 2012 and 2014, according to Standard & Poor's.

    Tighter borrowing conditions will mark a turning point in the recent debt binge. Companies have had easy access to cash to write cheques for multibillion-dollar takeovers, to fund buybacks and dividend strategies - all welcomed by investors as share prices rallied off 2009 lows.

    But as rates turn higher, investors may see the flip side of cheap financing. Analysts warn companies will begin defaulting in greater numbers, particularly in the energy sector, which has found itself in the line of fire as commodity prices languish.

You will hear from the talking heads that America's corporate sector has never been in better shape. Profit margins are near all-time peaks. And cash-to-equity ratios are as good as they've been...well....since 2007!

Here's what has happened. Corporations hoard their own cash. Then, with their cash hoard and high equity prices as collateral, they are able to borrow at rates so low you need to get on your hands and knees to find them. This borrowed money is used to boost their own share prices, as mentioned above. So, presto, the trick is done right in front of our eyes - with share prices rising, the debt/equity ratio 'never looked better'

But wait.

The FT again:

    Moody's and S&P warn that defaults are likely to increase in the coming years as interest rates rise, a concern echoed by bond funds such as Pimco. Analysts with S&P expect defaults among junk-rated US companies to hit 2.9 per cent by June 2016, nearly twice the rate in 2013. Moody's list of companies rated B3 with a negative outlook or lower - its lowest rating rungs in the "speculative" space - eclipsed 200 for the first time since 2010 in July

    "Credit quality has been deteriorating by and large over the last three years," says Bill Wolfe, an analyst at Moody's. "Speculative grade companies, they've taken advantage of very buoyant market conditions over the last few years. The number of weakly rated companies we rate is much greater than it used to be."

And here's Eugen von Bohm-Bawerk with a warning. Corporate America faces a huge margin call:

    Net debt, that is credit market liabilities less cash, has actually never been higher.... sitting at more than US$6.6 trillion, non-financial net debt outstrips even the high from 2008.

Corporations borrowed, jacked up their share prices, and then were able to borrow more. But what happens when the cycle reverses...when equity prices fall and suddenly the collateral isn't as valuable as lenders thought?

We know exactly what happens, because it happened twice before in this century. In 2000...and again in 2008...equities fell, credit collapsed...and things headed back to a more normal situation, until the feds got on the case again. In both cases, equity prices rose preceding the stock market break. As equity prices rose, the debt/equity ratio went down. The gap between the two - market capitalization and the debt/equity ratio -- widened...until the stock market went into a dive.

And today, the gap is nearly twice as great as it was in '08.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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