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Corporate Debt Reveals Disconnect Between Stocks and Economic Reality

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There has been a lot of volatility in the stock market over the last couple of months. Peter Schiff has been saying we are already in a bear market. But most mainstream analysts remain upbeat. They insist the recent volatility is normal. The economy is picking up steam. Inflation remains tame. The jobs market continues to grow. Everything is great!

But there are realities underlying this market few people seem to be paying any attention to, and they reveal a serious disconnect between corporate America and Wall Street.

Companies are drowning in debt.

As a report on True Economics put it:

The positivity of recent headline has been contrasted by the realities of the gargantuan bubble in corporate debt. A bubble that is not going to get any healthier any time soon.”

S&P Global Market Intelligence recently released data showing that credit ratings turned decisively negative in the second half of 2017. Corporate credit downgrades have outpaced credit upgrades since the first quarter of last year and the spread between the two has gotten progressively worse. In the fourth quarter of 2017, the number of credit downgrades was better than 50% higher than credit upgrades.

In other words, debt is catching up with more and more companies.

As True Economics noted, this raises a question:

If things are getting downgraded that fast, what’s likely to happen with the Fed policy ‘normalization’ impact on the corporate credit markets? Answers on tears-proof napkins, please.”

The answer is self-evident. As the Fed attempts to push interest rates up, we will likely see a significant increase in corporate bankruptcies as the increased cost of debt service squeezes the life out of strapped companies.

We’ve already seen a number of high-profile corporate bankruptcies, particularly in the retail sector. Toys R Us was probably the highest profile. It ranks as the second-largest US retail bankruptcy ever, according to S&P Global Market Intelligence. Most people blame Amazon, but the real story behind the Toys R Us bankruptcy gives us a glimpse at a fundamental problem eroding the strength of the economy – easy money created by Federal Reserve monetary policy.

The rate of bankruptcies will likely accelerate over the next several years and spread into other sectors if the Fed follows through on its monetary tightening policies. The ugly truth is that these overleveraged companies simply can’t survive in anything remotely resembling a normal interest rate environment.

There is additional evidence that a bankruptcy epidemic could be on the horizon. Consider these two factors.

  • Corporate net debt to EBITDA levels is at record highs. About 20% of US corporates face default if rates rise, according to the IMF.
  • The number of zombie companies has risen above pre-crisis levels according to the Bank of International Settlements (BIS).

The pundits can keep talking up stocks all they want. The economic realities simply don’t support their optimism.

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