Barron’s recently invited 10 leading financial minds to look into their crystal balls and predict how capital markets may fare in 2019. This round table is always interesting, but you have to remember panelists’ perspectives are usually tied to the industry that pays their salary. Abby Joseph Cohen is still representing Goldman Sachs.
This year a few of the panelists broke rank and gave a sobering look at the issues corporate America is facing on account of debt based tactics to goose earnings at the expense of balance sheets. Debt based prosperity is suddenly a significant concern.
By way of background, The Daily Shot also rang the same bad weather bell when it showed this surprising capitalization factoid:
It is hard to believe that 36% of small publicly traded stocks do not have earnings but this is consistent with a blog I published earlier about the noticeable rise in so called Zombie stocks (“Zombie Stocks Look Pretty Lively” and also a blog I wrote in October (“You Know It Is A Top When”) suggesting the equity market was peaking as management teams leveraged their companies to buy back their stock.
Those two themes were also voiced by a number of Barron’s’ panelists:
Jeff Gunlach, CEO and CIO DoubleLine Capital: “ The biggest risk is in the corporate bond market…A Morgan Stanley research report suggests that, based on leverage ratios alone, 45% of investment grade corporate bonds would be rated “junk” right now. The report further suggests that around 60% of corporate bonds currently rated BBB would be rated junk right now.” This situation arises as Central banks around the world are removing liquidity, and in the US, raising rates.
William Priest, CEO and co-CIO of Epoch Investment Partners:” Quantitative tightening, or QT, impact will be profound. In my view, quantitative easing was necessary after the financial crisis to offset liquidity and solvency issues. We probably should have stopped QE in 2011, but that’s hindsight. QE artificially drew down the discount rate for all financial assets and was a fantastic stimulus to the stock market.”
Rupal Bhansali, Chief Investment Officer, Ariel Investments “Cash will no longer be a four-letter word. Debt will be a four letter word. The thing to bet on the coming years is net-cash companies”…Investing is ultimately about figuring out the unexpected because the expected is already in the price. That’s why corporate leverage isn’t just a problem for fixed income markets, but is a bigger one for equity markets. Equity investors need to remind themselves of their status in the corporate structure.”
Fixed Income Manager Sounds same Warning
Piling on with its own warning, the fixed income experts at Wasmer Schroeder & Company published a year-end review of corporate debt markets. Here is what Christopher Sheehan, Vice President, Senior Portfolio Manager wrote about the proliferation of BBB rated debt in almost all indices:
I have to admit that it is rare to see so many panelists pointing to the same unrecognized risk factors. I also can’t recall anyone talking about corporation balance sheets this much since I started investing in the early 1970s. Maybe deep value, active investment will be back in style soon?