This Is Why It’s Going to Get Even Tougher

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The third quarter was tough for US corporations. Worse than the prior two quarters. They got waylaid by weak global demand and lack of pricing power. The easiest way to increase revenues and profits is to raise prices, so via inflation, but that strategy isn’t working when consumers don’t have the additional income to pay for higher prices.

Then there’s the “strong dollar.” On Thursday, Draghi evoked more QE and even more negative deposit rates, which eviscerated the euro and made the dollar a heck of a lot stronger. And so many US corporations are now reporting declining revenues.

It isn’t just the energy sector. For the 142 non-energy companies that have reported Q3 earnings so far, revenues dropped 3.0% year-over-year, according to Moody’s Credit Markets Review and Outlook. Operating income of these non-energy companies fell 2.7%. In this environment, companies try to maintain their bottom line by cutting costs.

“Results such as these weigh against expecting much of a pick-up by either hiring activity or capital expenditures,” Moody’s warns gloomily. Both have been dreary recently.

Cheap money is no longer readily available to riskier borrowers. In the third quarter, bond issuance by junk-rated companies plunged 38% from a year ago. Yields rose as the spread between high-yield bonds and Treasuries soared. And in October, according to S&P Capital IQ’s LCD, it has been even worse: just seven junk-bond deals through Thursday, for a measly total of $3.7 billion.

Leveraged loans are in a similar quandary. These loans issued by junk-rated companies, often for special dividends to their private equity owners or for M&A, are so risky for banks that regulators have been cracking down on them for two years. Banks usually sell them, either directly to funds or repackaged as Collateralized Loan Obligations (CLO). But during the Financial Crisis, banks got stuck with them. And now leveraged loan issuance is petering out.

Total high-yield borrowing (junk bonds and leveraged loans combined) plunged 37% in the third quarter from a year ago, according to Moody’s. And for the 12-month period, total issuance is down 29% from the 12-month all-time record in Q4 2013.

But here is the thing: within 15 months of the three prior peaks of total high-yield borrowing – the all-too-familiar periods of Q3 2007, Q4 1999, and Q4 1989 – recessions occurred.

Moody’s tries to assuage our frazzled nerves:

Though it is most premature to predict impending doom for the current recovery, the latest dive by high yield borrowing warns that the current upturn has lost its youthful vigor and with age has become more vulnerable to adverse shocks.

The problem is that this reduction in borrowing by junk-rated companies – including many big players – “is capable of stalling overall spending.”

It didn’t just hit oil-and-gas companies. Worldwide issuance of high-yield corporate bonds plunged 30% in Q3 year-over-year: while issuance by oil-and-gas companies plummeted 83%, issuance by other companies plunged 21.5%.

And there’s another troubling aspect: the deterioration of overall corporate credit ratings. High-grade borrowers (rated A2 or higher) have access to funds even in difficult times, but their number has been shrinking as companies have mucked up their balance sheets by borrowing more for M&A and share repurchases. There is a real cost to financial engineering: downgrades have pushed these companies into lower credit categories.

Through 2011, high-grade companies were the top bond issuers. But now “medium grade” companies (rated A3 or Baa) have become the most prolific bond issuers.

From 1995 through Q2 2012, issuance by high-grade companies was on average nearly double the issuance by medium-grade companies. But since then, medium-grade offerings outpaced high-grade offerings on average by 24% per year. By Q3, medium-grade issuance soared 47% year-over-year “despite higher yields and wider spreads,” and even as junk-bond issuance collapsed.

There are now a total of $3.36 trillion in medium-grade bonds outstanding. During the 10-year period ended in 2005, medium-grade bonds averaged 31% of total bonds outstanding. Now their share soared to 52%. The share of high-grade bonds, at $1.79 trillion, has plunged to 28% in Q3. And the share of junk bonds outstanding, the most vulnerable of the bunch, has soared to over 20%.

Many of these companies were downgraded since they issued these bonds a few years ago. And when these bonds mature, they have to be refinanced with lower-rated, and thus more expensive, debt – if they can refinance them at all.

This deterioration in credit indicates that companies are losing “financial flexibility,” as Moody’s puts it. Lower-rated borrowers are experiencing higher credit costs. For them, access to credit becomes difficult, or even impossible. That’s when they run out of money and end up in default.

Moody’s concludes:

To compensate, corporate outlays on staff and capital goods may be curbed more rapidly in response to a weaker business outlook.

This sort of cost cutting via layoffs and slashing of capital expenditures has been wreaking havoc in the energy sector for a year. But it’s spreading, as the recent rounds of layoff announcements and cost reduction programs have shown. This sort of reaction to tightening credit is how it started out at the end of last three credit booms – the ones that ended in recessions and a financial crisis.

Risks have been building up in the banking sector. “Reminds me of what happened in mortgage-backed securities in the run up to the crisis,” explained the Comptroller of the Currency. Read… “Bank Failures and Systemic Breakdowns”: Regulator Warns on Autos, Subprime, Commercial Real-Estate…

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  26 comments for “This Is Why It’s Going to Get Even Tougher

  1. michael
    Oct 23, 2015 at 3:55 pm

    Wolf,
    do not forget …..we can watch the stock market ratchet ever higher while our economy collapses.

    • Oct 23, 2015 at 6:15 pm

      Sure looks like it :-]

      • Oliver
        Oct 25, 2015 at 10:56 am

        What we have here is classic beggar-thy-neighbor monetary policy:

        – FED loosens monetary policy (relative to expectations of rate hike; the USD falls, against the Euro and others, making U.S. exports more competitive;

        – A few weeks later Drahgi brazenly trumps the FED´s (non)move, driving down the Euro, and making Eurozone exports more competitive

        – A day or so later, China announces another cut in rates, which will likely weaken their currency, and make their exports more competitive.

        This wreaks of competitive devaluation, pure and simple.

        But, the horse still won´t drink … adding more water doesn´t suddenly make the horse thirsty. And, coloring the water green, pink or blue just makes the horse burp: ´Who do you think you´re kidding ?´

    • MARK
      Oct 24, 2015 at 12:44 am

      I lost $20,000 a year in business after this jackass got elected. The 1% of the rich isn’t the problem. The .1% of America is the problem, Politicians.

      • Oliver
        Oct 25, 2015 at 10:10 am

        Politicians are like salespeople: they respond to the incentives they´re given … that´s why there is so little (prospect of) change, even with the glaring shortcomings and breakdowns in the system

        We can rant all day long and occasionally throw the rascals out, but meaningful change (e.g., campaign finance reform) is a lot harder to come by, and is likely only when you have a broadbased breakdown.

  2. ucde
    Oct 23, 2015 at 4:14 pm

    Its interesting, this ongoing questioning which I observe in the economics blogosphere: “Are we in a crisis? Is there about to be a crisis? Do these metrics indicate a crisis or a slowdown?”

    Steve Keen makes an interesting point in this video:
    https://www.youtube.com/watch?v=rGkmgnprrIU

    He says: “We’re already in one [a great depression], and the same thing applies as to the prior one: people didn’t actually refer to it as the Great Depression until after it was over. In an experience like this you’re always hoping that there’s change just around the corner, that things will turn around; its only after its been going for years that it gets acknowledged for being what it is.”

    Pretty cool insight.

  3. walter map
    Oct 23, 2015 at 5:42 pm

    The situation is not going to improve for the simple reason that there is nothing in sight to improve it. And there won’t be. The plutocracy holds all the cards, and it has elected to simply liquidate the U.S. economy.

    It gets worse the more you look at it. The meltdown of the financial economy in 2007-2008 has been controlled by the slow destruction of the real economy which it parasitizes. The financial economy has been able to recover from that catastrophe through debt imposed on the real economy, guaranteeing that the next downturn will be cataclysmic and making it unlikely the U.S. economy and global economy will ever recover.

    Debt peonage through loansharking has been the favored means of destroying people for fun and profit by the cosa nostra for as long as it has existed, but it learned it from the banksters, and they have been doing it to entire nations ever since Philip the Fair ruled France. Now they are in position to do it to the entire world. Permanently.

    “… the powers of financial capitalism had another far-reaching aim, nothing less than to create a world system of financial control in private hands able to dominate the political system of each country and the economy of the world as a whole …

    “This group is responsible for the death and suffering of over 180 million men, women and children. They were responsible for World War I, World War II, the Korean War, and Vietnam, etc. They have created periods of inflation and deflation in order to confiscate and consolidate the wealth of the world. They were responsible for the enslavement of over two billion people in all communist nations – Russia, China, Eastern Europe, etc., inasmuch as they were directly responsible for the creation of communism in these nations. They built up and sustain these evil totalitarian systems for private gain. They brought Hitler, Mussolini, Stalin and Roosevelt to power and guided their governments from behind the scenes to achieve a state of plunder unparalleled in world history.”

    Carroll Quigley, Tragedy and Hope: A History of the World in Our Time. Macmillan:New York (1966)

  4. Oct 23, 2015 at 10:32 pm

    You probably cut off the whole quote concerning layoffs. If you didn’t the rest of the quote would go like this:

    “…and first round of layoff will be the day before Thanksgiving. While the second round will be December 24.”

  5. LG
    Oct 23, 2015 at 11:13 pm

    Pay off your credit card debt pay off you car! Try to refy your home with a 30 years fixed to lower your payment. Yes, 30 years, your home will drop in value 30-50 % when the storm hits!
    If you got cash start stuffing it where ever you prefer.
    Plan on deflating your prices if your are business owner to stay competitive And plan on getting a second or third job if you are employed.
    The avalanche in layoffs has begun it’s going to get very ugly after the holidays!

  6. Nick Kelly
    Oct 24, 2015 at 1:04 am

    You’ll know you’re in a depression when you have to knock on (back) doors looking for a sandwich.
    I’m in to all this doom and gloom as much as anyone on this site.
    But people need to keep things in perspective and count their blessings

    • Oct 24, 2015 at 4:33 am

      Wow! You sound like President Lincoln and Martin Luther King. Not to mention Jesus and John the Baptist. But then Lloyd Blankfein and Jamie Dimon suggested we count our blessings as well.

      • Nick Kelly
        Oct 24, 2015 at 4:32 pm

        Guess you have a computer, and internet and unless its solar powered, electricity, and leisure. Roof?
        I mean when you see those refugees trecking across Europe…
        Now they have something to whine about.

        • Pedro Cabral
          Oct 28, 2015 at 5:15 pm

          The demographics do not accord with the label ‘refugee’c

    • ucde
      Oct 24, 2015 at 9:23 am

      My view is that we might not know just from thinking about it what a modern depression looks like. It wont look exactly the same as the Great Depression, because the world has completely changed. We might never be begging for sandwhiches, we just might have to work 3 shitty jobs to rent a studio apartment and make rent — forever.

      I mean c’mon, however bad this depression gets, a large percentage of the *World Population* now own smart cell phones. That alone should clue us in that everything is going to be completely different, imo.

  7. MC
    Oct 24, 2015 at 6:26 am

    It seems rating agencies have learned at least part of the 2008 lessons: remember how Fannie Mae and Freddie Mac were rated just in September of that year?

    And I think there’s another theme here at play: in spite of the “irrational exuberance” displayed by stock markets, investors are becoming more cautious with their money. Financial repression worldwide notwithstanding (and it’s about to get a whole lot worse if you live in Europe, eurozone or not) the appetite for yield at any cost is waning.
    I think I speak for many other investors when I say what drove me away from corporate bonds early this year was the ridiculous gap between the risks we were asked to take and the potential rewards: for me the tipping point was discovering BB euro denominated corporate bonds yielded all of a massive 1.76%. Take away capital gain taxes and we are looking at less than 130 base points. Seriously? No wonder the ECB QE program has been expanded to include BBB+ corporate bonds and will most likely get to BB territory sooner than I’d like.
    This is ultimately counterproductive, as yields are pushed well below where they should be and investors throw the towel in and take refuge in fixed yield, cash and US dollar/ChF denominated assets. The whole QE charade was about helping Italy, Spain etc to service their debt and make junk bonds palatable to investors by taking away the “lure” or reasonably yielding investment grade paper, not scaring people away.
    Am I the only one remembering when Bunds yielded 3%? Good times, investing was a whole lot easier…

    Now companies not at the receiving end of the central banks’ largesse are stuck in the mud and sinking fast. Unless they start offering yields that can land them in hot financial troubles, nobody is going to touch them with a 10ft pole. I sure won’t: I refuse to mortgage my future and that of my family to allow a financial zombie to lumber around a little longer so people can have their jobless “recovery”. And it seems I am not the only one.

    • Petunia
      Oct 24, 2015 at 8:57 am

      You are wise to sit out any situation that doesn’t make financial sense. Investors rarely think of sitting it out as an investment strategy. My only other suggestion is to hold some physical cash for emergencies. Remember, that in Greece, they closed the banks for weeks, and no one had access to safe deposit boxes either.

      • MC
        Oct 24, 2015 at 9:45 am

        Physical cash is a bit of a problem because “to fight tax evasion” the total amount has been limited for almost a decade now. How much you can withdraw at any given time (and mind we have no capital controls) is left to decide to each single bank but it’s usually no more than 1000€. My bank also told me they are progressively reducing physical cash they have available (and mind we are talking about the largest local office of the largest national bank) and do not stock foreign currency anymore. They used to have small amounts of US dollars, British pounds etc for customers who needed some spending cash when traveling abroad and didn’t want to be fleeced by credit card companies.

        Now, somebody must have been hoarding cash because 200 and 500€ notes have completely disappeared from circulation (haven’t seen any of the former in two years and the latter in five) and even 100€ notes are getting hard to come by. I often get paid with packs of 50€ notes which make me look like an underworld figure… it would make for a fine postulate to Gresham’s Law.

  8. Petunia
    Oct 24, 2015 at 8:25 am

    A few observations on the real economy from a housewife. There are fewer sales at the supermarket, much less discounting and less selection, than in the last few years. We are buying more take-out these days because the cost is only slightly higher than making a meal at home.

    I was in two major middle market department stores this week, and inventories/selection are lower than they were pre 2008. I don’t know if the stores are less stocked because they are selling more online. However, I found the basics I needed on sale.

    Service businesses are busy. The nail salon, the hairdresser, and the restaurants are all busy at the local mall, while the regular retailers are not.

    My general impression is that the way people are spending has changed since the financial crisis. Whether you have money or not the consumer economy is different now then it was pre 2008. All the kids have smart phones and torn jeans. They are spending on better grooming, trying to have fun, and don’t care so much about stuff.

    • Nick Kelly
      Oct 26, 2015 at 7:27 pm

      And how about the price of beef and I don’t mean strip loin. Wasn’t hamburger along with spuds and bread how the poor got by?
      Now here in Canuck land lean ground is usually about 12 a kilo. which would be about 5 a lb $C.
      Normally these prices would cause the herd to expand but the drought in Alberta means its getting smaller.
      Pork thank heaven remains very cheap- got nice already cut chops for 4.50 kilo about 2 bucks lb.
      And budget blade- Jees – up to 15 a kilo for steaks?
      I just feel for someone on a budget who can’t afford to make their kids hamburgers.

  9. ERG
    Oct 24, 2015 at 8:59 am

    Until recently, the only segment of the US economy that had the appearance of health was energy. That has now turned out to be yet another 3 dollar bill created by ZIRP malinvestment.

    Now that it’s gone, our economy has returned to being held together by horses**t and toothpicks. Plan accordingly.

    • walter map
      Oct 24, 2015 at 10:55 am

      No doubt you’re aware that so far as TPTB are concerned, you and I and the rest of the 99.9999% are essentially livestock, and just as disposable as the cows, chickens, fish, trees, oceans and atmosphere. You can tell by how they have no problem ginning up wars that kill millions and letting millions more perish from starvation and preventable disease, year after weary year. Wiping out entire countries and entire ecosystems doesn’t seem to present a problem for them. Ethics and morals are null concepts.

      You’ll notice that members of the common herd are normally allowed to live a decent, conventional life only on condition that they enrich the wealthy, with the rest are consigned to abject destitution. Which is to say, if you’re not making them money you’re just a waste of their planetary resources and a drag on the bottom line. You may wish to consider that catastrophic climate change might just be their way of disposing of a few billion nonperforming human assets by culling the herds.

      From here it looks like TPTB are in some kind of weird contest to see who can die with the most toys. This would explain why preventing the destruction of civilization or preserving the continuation of the species really doesn’t appear to be one of their priorities.

      Not sure how you’d ‘plan accordingly’ for that, but I’m open to suggestions.

      • nigelk
        Oct 24, 2015 at 12:04 pm

        Seconded. If anyone thinks the Plutocracy sees their relationship to non-member of their club as anything north of Tsar-serf, you’re deluding yourselves.

      • nigelk
        Oct 24, 2015 at 12:05 pm

        …and I’d add that the solution is the same for the Plutocrats as the Years, as well.

        • nigelk
          Oct 24, 2015 at 12:06 pm

          *Tsars
          Gotta love autocorrect

  10. Dave Mac
    Oct 24, 2015 at 3:23 pm

    Corporate and national debt levels are way too big to ever be repaid. The entire global system needs a reset, much like the severe market correction during 1929-32 where the Dow dropped 89%.

  11. Duane Snyder
    Oct 24, 2015 at 3:57 pm

    Yea but McDonalds in using butter instead of margarine on their egg-a-muffins. That trumps all y’alls doom and gloomery.

Comments are closed.