The Noose Tightens one by one.
You wouldn’t know it from the boom in stocks that hit new highs after tottering for over a year, and from the surge in junk bonds, even the riskiest ones, whose prices have soared and whose yields have plunged: At the riskiest end of the spectrum, the average yield of CCC-and-below rated junk bonds went from 21.5% on February 12 to 14.2% now, as if all credit problems, defaults, and bankruptcies had suddenly disappeared after the latest Fed flip-flop or whatever.
But in reality, companies are buckling under their load of debts in an environment of slack demand and declining sales. The Standard & Poor’s default rate has been rising relentlessly, and in June, following a number of new defaults, hit 4.3%, the highest rate since the Financial Crisis.
And now Fitch Ratings chimes in with its Fitch Fundamentals Index (FFI). “As a pattern of weakening credit quality, mostly in the corporate finance space, took its toll,” the index dropped to -3 in the second quarter, the lowest since the third quarter of 2009, when the Financial Crisis was in full swing.
The FFI, which ranges from +10 to -10, serves as a gauge of “credit fundamentals” across the US economy, as Fitch says. These include the performance of mortgages and credit cards, corporate defaults, recoveries after high-yield debt defaults, rating actions and Outlooks, forecasts of EBITDA and CapEx, the health of the banking sector, the CDS outlook, and transportation trends. Fitch:
Analyzing the relative strength or weakness of the index or its sub-components can provide insight into how conducive conditions in the US are towards economic growth.
And they’re not very conducive: six of the 10 components in the index are now “in negative territory, three of those strongly so.”
The mortgage performance component is the only score “in strongly positive territory as prime mortgage delinquencies remain low.” And that is a logical function of home prices that have been soaring beyond prior bubble highs in most places. Even if borrowers can’t make the payment in an environment of rising home prices, they can sell the home and pay off most or all of the mortgage. Mortgages don’t curdle until home prices decline sharply.
As for the remaining nine components? Three are at the lowest possible level of -10:
- CDS outlook
- Corporate defaults
- High-yield recoveries. This is when bondholders find out what’s left for them after a default. Recoveries have dropped to an average of $0.20 on the dollar, which is, as the report says, “among the lowest that Fitch has seen.”
And there was more deterioration in other components:
Concerns over global growth and commodity prices persisted, pushing the corporate capex forecast indicator into negative territory while the corporate EBITDA forecast indicator [Earnings before Interest, Taxes, Depreciation, and Amortization is a measure of cash flow], although still positive, was less so than the prior quarter. Average corporate capex growth stands at just 2%, as companies weigh the costs and benefits of new investment.
This dearth of “new investment” has been one of the weakest points in this Fed-designed economy. Companies simply don’t use the funds that they can borrow so cheaply to invest in productive activities, in part because they don’t see enough demand, and in part because they’re more interested in propping up their share price via share buybacks, aggrandizing their reach and power, and eliminating competition via mergers and acquisitions.
They’ve been borrowing to buy back their own shares, and to acquire other companies by overpaying and then downsizing the company to deliver the “efficiencies” they hyped when they announced the deal. That isn’t an investment in the future, but capital evaporation. Left behind is the debt incurred to do this. And what they’ve not been doing enough of is, as the capex component points out: investing for the long term and moving their business forward. Now the fruits of these efforts are ripening.
What keeps these companies and their debt afloat for as long as it has been the case is the tsunami of global central-bank-created money and zero- or negative-interest-rate policies. The markets have been playing along. They’re focused only on the marching orders issued by central banks, and those orders have been simple: buy, buy, buy — and by the way, here’s some free money for leverage. It has created the biggest credit bubble in US history. But on a company by company basis, this debt that keeps piling up needs to be serviced. It doesn’t just go away. And the longer the unwind gets dragged out, the more there is to unwind.
For many American consumers, this credit bubble, however, hasn’t been helpful. On the contrary. Read… Americans’ Economic Gloom Festers as Stocks Hit New High: Gallup Stumped
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.