Monday, February 22, 2016

Bank of America: "Corporate Balance Sheets Are The Most Unhealthy They Have Ever Been"

Bank of America: "Corporate Balance Sheets Are The Most Unhealthy They Have Ever Been"

In our opinion, we think the biggest issue in the market is the buildup of corporate leverage without a place for it to go. And what will likely cause peak spreads is not an increase in defaults, but a capitulation moment that creates a rush for the exits. In this way, we think the 1989 and 2008 cycles are more representative of what we could see this go around, as max spreads occur before the highest defaults - whether that is in 2016 or 2017 will depend on the timing of the catalyst.

The ensuing crisis is likely to be one defined by the excessive credit creation in the corporate market. Should a market meltdown be accompanied with a lack of inflationary pressure, the credit creation of the last 5 years will likely be met with a period of significant credit destruction.

And in a world where corporate balance sheets are arguably the most unhealthy they have ever been (all-time high leverage in HG and HY) where companies have relied on cheap debt to fund a growth through acquisition strategy, what happens if funding is either unavailable or too expensive to make a growth through acquisition strategy make sense?

Same goes for buybacks and special dividends? 

Then one would have to cut capex. But with little capex to cut, personnel could be cut next (particularly if those people are beginning to cost more). And when coupled with a consumer that is already saving 5.5% of disposable income, should we see layoffs amidst an already low GDP, poor CEO confidence, and banks that are risk averse and perhaps hurting with commodity exposure, things could potentially get very messy in such a scenario. THINK FAR WORSE THAN 2008.

Herein lies our concern for markets and where the fear of a Fisherian debt deflation spiral can become worrisome. Although it is unlikely that the corporate market is enough to cause outright deflation, certainly a corporate credit bust can create disinflation or enhance deflation if it already exists. As liquidation leads to falling prices, dollar strength causes the very debt that needs to be paid down all the larger. Liquidation leads to defaults and layoffs, which, in a post-Volcker world, would likely cause banks to pull back on lending even further. The lack of lending coupled with job losses could create a weak consumer, which would further propagate a negative feedback loop to corporate earnings and further liquidation.  AT SOME POINT SOON THIS IS GOING TO HAPPEN AND CENTRAL BANKS HAVE NO POWER TO STOP IT, NONE. ALL THEY HAVE IS HOT AIR AND VERY GOOFY THEORIES. 



 

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