By Justin Spittler, editor, Casey Daily Dispatch
This could ignite the next major financial crisis…
And it could happen sooner than most people think.
I’m talking about the explosion in corporate debt.
At the Dispatch, we’ve been preparing you for this for months now. Make sure to read our most recent essay on the subject here.
But the corporate debt bubble doesn’t just pose a threat to financial markets…
As we’ve shown you, it’s also a huge threat to the economy at large.
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• Now, the Federal Reserve is saying the same thing…
Last week, Robert S. Kaplan – who heads the Dallas Fed – penned an essay titled “Corporate Debt as a Potential Amplifier in a Slowdown.”
You can read the entire essay here if you’d like. But it’s not necessary.
In short, Kaplan is worried about how much corporate debt there is since the global financial crisis. He’s also concerned by the huge deterioration in corporate debt quality.
In fact, he’s so concerned that he says corporate debt “could potentially amplify the severity of a recession.”
That’s right. The huge buildup in corporate debt could be what turns the next economic downturn into a full-blown crisis.
And we have good reason to think the corporate debt bubble will pop soon. I’ll explain why in a minute.
The good news is that there’s still time to prepare. I’ll show you how at the end of today’s essay.
But I should say something first…
• The Fed should have seen this coming from a mile away…
After all, it created the giant corporate debt bubble.
Regular readers know where I’m headed with this…
In 2008, the Federal Reserve dropped its key interest rate to effectively zero and held it near there for almost seven years.
This unprecedented intervention flooded the economy with cheap credit. It encouraged everyday Americans to borrow obscene amounts of money. Corporate America did the same.
In fact, corporate debt as a percentage of U.S. gross domestic product (GDP) – the most popular measure of economic growth – is now higher than it has ever been.
Of course, corporate debt levels have been swelling for years. And they’ve yet to create major problems for the economy.
But that could soon change…
• The U.S. economy is starting to weaken…
Last Friday’s ugly jobs report is the latest proof of this.
According to MarketWatch, the U.S. economy added just 20,000 jobs in February. That’s the smallest increase in the last 17 months.
It’s also well below the 233,000 new jobs that the U.S. economy added on average every month for the past 12 months.
So this is a big problem. If it continues, the U.S. economy could be in serious trouble.
Even the Fed now admits this. More from Kaplan’s piece:
In the event of a downturn, highly indebted companies may be more vulnerable to seeing their credit quality deteriorate, which could negatively impact their capital spending and hiring plans. If this deterioration were sufficiently widespread, credit spreads would likely widen in order to compensate lenders/bondholders for greater risk. This type of widening would likely be indicative of an overall tightening in financial conditions that could, in turn, lead to a more significant slowing in the economy.
In other words, a slowing economy could lead to a huge spike in corporate downgrades and defaults. This would make it more expensive for many companies to borrow money and service their debts.
In turn, that would force companies to rein in spending, which would hurt the economy.
In short, we could be on the cusp of a vicious cycle where the slowing economy could cause borrowing costs to rise. And that will only hurt the economy even more.
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• The Fed will do whatever it can to prevent this…
In fact, it’s already come off its latest rate hike talk.
You see, the Fed lifted its key rate four times in 2018. And it planned to hike it two more times this year.
But it’s clear that’s not going to happen.
After Friday’s ugly jobs report, the market puts the odds of a rate hike at 0.6%. Not only that, it’s now pricing in a 16.6% chance of a rate cut.
In short, the Fed looks like it’s about to do a complete 180 on its monetary policy. That tells you all you need to know about the strength of the U.S. economy.
• I’m not the only Casey Research analyst concerned by this…
Casey Report chief analyst Nick Giambruno sees the same scenario playing out. He wrote in his January issue:
US companies are choking on debt. Artificially low interest rates are the only thing keeping them alive.
Not only that, nearly $4.5 trillion of corporate debt will mature over the next four years, according to Standard & Poor’s. That’s over half of the total market.
Companies will need to roll over a lot of this debt. And with rising interest rates, they won’t be able to do that with the ultra-low interest rates they’ve grown accustomed to over the past 10 years.
But again, it’s not just the amount of corporate debt that’s concerning.
• The quality of U.S. corporate debt has also deteriorated significantly…
We know this because there’s been an explosion in BBB-rated corporate debt since 2007.
BBB-rated bonds are investment-grade bonds. But they’re the riskiest investment-grade bonds money can buy.
In just the last 12 years, the BBB-rated corporate debt has grown by more than 400%. It’s now a nearly $3 trillion market. That makes it twice as big as the subprime mortgage market at the height of the last housing boom.
Not only that, BBB bonds now make up about 50% of the so-called “investment grade” market. That’s an all-time high. That’s a problem, as Nick explains below:
Over a trillion dollars’ worth of BBB rated corporate debt could easily get downgraded to “junk” as interest rates rise or as the next economic downturn, which is long overdue, hits in earnest.
Nick is, of course, referring to junk bonds. These are bonds issued to companies with shaky credit. They pay higher interest rates than bonds issued to companies with strong credit.
In short, the slowing economy could cause a wave of downgrades to rip across the corporate debt market. That would make it difficult for many highly indebted companies to pay off their debts.
That’s the last thing that the debt-addicted U.S. economy can afford. But there’s still time to prepare.
• I suggest you “look under the hood” of any corporate bond funds you own…
You can do this easily (and for free) on Morningstar. Just click the “portfolio” tab once you’ve found the fund you own. There you can see a breakdown of the bonds the fund owns.
Make sure that you have heavy allocations to “AAA/AA/A”-rated bonds, the safest kinds you can own. This simple step will help prevent you from having massive losses as the credit cycle reaches its tipping point.
• I also recommend owning physical gold…
If this trend goes the way we expect, we could be looking at a financial crisis for the history books. And owning gold is the best way to protect yourself from this.
As we often point out, gold is real money. It has preserved wealth for centuries. It has also survived every major financial crisis in history.
This makes gold the ultimate safe-haven asset. Learn the best ways to buy and store it in our free special report: “The Gold Investor’s Guide.”
Regards,
Justin Spittler
Florianópolis, Brazil
March 11, 2019
Reader Mailbag
One reader chimes in on the debt issue…
The reason the market hasn’t crashed yet is because it is being fueled by the big money corporations as they borrow money at almost zero interest and buy back their own stock, so they don’t have to pay out dividends… Smart move but it gives the common person a false impression of how well things are doing in the investment world. It is false hope.
– John
And another writes in about our climate change hoax debate…
Hi! Loved the article re: climate change. Ironically humans hate the cold, probably why two-thirds of the world’s population live in the tropical/subtropical zones. The so-called bad gasses are all soluble and with two-thirds of the world’s surface area being water and ice, do people think nature is not going to look after us by absorbing these gasses and the ocean sea grasses absorb these nutrients in massive amounts to produce prolific growth which actually assists all the marine life.
As far as high ocean temperatures destroying marine life goes, it is crap… I have worked in five countries commissioning Coal and Gas fired Power Stations and the cooling water discharge temperature to the ocean is usually licensed to a max of 37 degrees Celsius, and I can assure you the marine fishes and crustaceans’ growth and numbers are prolific. CO2 is essential for plant growth, so it may well be higher levels increase farm produce productivity to feed the masses could be a positive.
Just the improvements in engineering of the combustion process, engine emission reductions, phasing out of two-stroke engines, the introduction of electric cars and bikes will have huge compensative effects, so we may be worrying about something nature and the engineers and general evolution will look after in the future generations. Regards, Retired Engineer.
– Ron
As always, send us your thoughts at [email protected].
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