The conductors of the crazy credit train – Janet Yellen, Mario Draghi, Mark Carney and Haruhiko Kuroda – are running out of tracks. Consider the following:
1. Central banks own $25 trillion of the world’s financial assets. That approximates 8%-8.5% of the total dollar value of stocks, bonds and the array of market-based securities available. The seemingly endless acquisition of corporate debt and sovereign debt has had an adverse effect on global bond liquidity.
Meanwhile, the foray by the Bank of Japan (BOJ) into equities has make Kuroda’s crew a top 10 shareholder in 90% of Nikkei 225 companies. The “buy-no-matter-what” central bank activity distorts the valuations of these corporations and, effectively, makes Japanese executives beholden to monetary policy authorities.
2. Twenty-five percent of bonds around the globe carry a negative yield. Few economists could even dream up negative yielding debt obligations in mid-2014. By August of 2016, $12.3 trillion of the world’s government and corporate bonds have negative yields. If you own any of the $4.3 trillion in corporate debt that falls into this category, you are paying public companies to borrow.
3. More than HALF of sovereign debt ($8 trillion) has gone negative. There was a time when owning a government’s I.O.U. implied that you could count on a risk-free rate of return. No longer. Holding a negative yielding bond to maturity now guarantees that you will receive LESS than your principal back when the debt matures.
Monetary policy insanity has not been lost on some of the world’s most influential voices. High profile pundits from DoubleLine’s Jeff Gundlach, Janus Capital’s Bill Gross, Jim Grant from Grant’s Interest Rate Observer, as well as George Soros and Stanley Druckenmiller have all warned about the adverse effects of global monetary policies on market-based securities.
The latest to chime in? The chief executive of Deutsche Bank, John Cryan, slammed the growth of negative-yielding debt as leading to “fatal consequences.”
Still, so many investors insist that central bank manipulation has been wonderful for corporations. Companies get to borrow money on the “ultra-cheap” for as long as the rate shenanigans and asset purchases continue. After all, why shouldn’t they issue debt obligations to a yield-starved investment community for as long as it costs virtually nothing to raise the capital?
Well, for one thing, just because a company can access credit for “next-to-nada,” it should not borrow without restraint. Total debt actually matters. And right now, corporations are leveraged to the hilt.
Corporate debt as a percentage of GDP? 45.3% is higher than the peaks leading into the previous three recessions. Cash as a percentage of debt outstanding? Below 28% is lower than it was going into the Great Recession. Corporate-Debt-to-EBITDA? 2.3 represents the highest level in the 21st century.
Some folks are critical of aggregate corporate data. If you show how companies have dramatically reduced capital expenditures from previous credit cycles – if you demonstrate how corporations simultaneously ratcheted up stock buyback levels from previous credit cycles – many dismiss the evidence as reflecting a few bad oranges.
If you provide data on how S&P 500 companies have abandoned responsible GAAP-based earnings while embracing non-GAAP “adjusted” earnings, you may get lectured on making sweeping generalizations about corporate deception. (You may even be told that traditional earnings-based valuation methods are useless).
The criticism of aggregate corporate data is eerily reminiscent of previous boom-to-bust credit cycles. As a national radio personality in the late 1990s, I can remember callers who explained that I just didn’t get it. “Gary, most of the companies listed on the NASDAQ are completely different from those on the NYSE. You have to value technology companies in the internet-based New Economy differently.”
I rejected the premise that dot-com corporations required a different valuation process. Not only did I agree to disagree with the mainstream thesis on breakthrough technology valuation leading into 2000, but I stressed the importance of reducing market-based risk of loss on the airwaves. Some folks listened; others did not.
Prior to the financial collapse in 2008? Same situation. Analysts routinely dismissed aggregate corporate data on the basis that a few bad financial companies did not make up the entire pie. Yet did all financial institutions lend foolishly? No. Did all financial companies find themselves over-exposed to subprime? No. Some were very responsible, actually.
Nevertheless, enough of the institutions had been foolish, and they took down the share price of every company – financial and non-financial – with them.
The bottom line? Central bank policies have caused corporations to tap too deeply into credit lines as well as to allocate capital in unproductive ways. Every single corporation? Of course not. Still, enough of them have been reckless to cause major ripples for market-based securities going forward.
It follows that I disagree with the “credit boom won’t go bust” crowd. And I have reduced, not eliminated, market-based risk of loss accordingly.
Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients June hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.