The level of corporate debt foretells a market correction.

Below is a chart showing the yields ( or interest) that companies pays for debt. BB-rated represents investment grade debt while CCC-rated represents junk bonds or debt of companies with lower profitability.

Large levels of debt will need to be refinanced in the coming years, about $900 billion this year and 1 trillion next year. Many companie didn’t take advantage and lock in the low rates for a long period of time when they had the opportunity and further, COVID pandemic has put additional strain on the company.

Now as the yields have risen, in the investment-grade level companies have been able to get the debt rolled to next period but the lower, junk-rated companies, companies with ccc rating, are going to have to roll the debt at much higher rates and they don’t have the cash to service the debt at the higher rates.

The companies recent performance in the stock market is largely due to share buybacks, and knowing that corporate profits have been dropping over the last few years there is little question as to whether the bulk of companies will be able to service their debt next year.

But aren’t Facebook, Apple and Amazon sitting on piles of cash? Yes but the top 3 companies of the S&P500 have more cash in their balance sheet than the bottom 400 combined

Here is a chart from Hedgeye that shows the concensus profit expectations at the end of last year.

Are investors repricing risk in the corporate credit market given that their earnings expectations are not going to come true? Are the investors repricing the market based on the renewed expectations of profits or rather losses? I hardly doubt that. The Federal Reserve has come in at every past credit crisis and granted cheaper debt to companies to help them “get out’ of this slump. As it stands in Q1 2020, it takes $7.50 cents in borrowing to generate $1 in GDP. And companies will continue to take on more debt at lower and lower rates because that is what is being offered to them.

Let’s look at the number of corporate debt rating downgrades this year. A downgrade is when a rating agency reduces the grade on a company’s corporate debt signaling to the market an increased probability of default. The number of 956 downgrade issues as of May 18th is way past the number of downgrades for the entire year in 2008 and 2009. The FED came out in April 2020 this year saying that they would support the investment-grade market (blue line) hoping that support would reverberate into the high yield market. Since that did not happen, In June 2020, the FED began buying high yield debt by purchasing a series of high yield corporate bond ETFs.

A point to note, ratings agencies generally react after the fact, think Fannie and Freddie during the housing crisis, so the chart is a trailing indicator, which in this case means the real situation is worse than it seems.

A point to note, ratings agencies generally react after the fact, think Fannie and Freddie during the housing crisis, so the chart is a trailing indicator, which in this case means the real situation is worse than it seems

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