Are We in a Corporate Debt Bubble?
2018 marks the 10th anniversary of the Great Recession of 2008. Despite a painfully slow recovery, U.S. economic growth has been sustainable. The stock and bond markets continue to perform well, unemployment is low and the economy is generally considered healthy and booming.
And yet, whenever things are going well, it’s only human nature to expect the “other shoe to drop.” Human nature and, well, the nature of the financial markets. The current concern among Wall Street analysts is the domestic corporate debt market, currently valued at $41 trillion.1
If we are heading toward another correction, analysts point out that recessions often start in the credit markets.2 After all, credit is the source of capital for everyone, from companies to municipal governments to individual consumers. And capital is what powers our economy forward.
While no one is raising the red flag for the near future, economists are looking down the road at what may happen in the next year to year and a half. If you’d like help evaluating your current financial strategy, please give us a call.
There have been a few developments in the way capital markets invest since the recession. Laws were passed that put more restrictions on how retail and investment banks could invest consumer deposits. In the past, they put customer funds at a higher risk, which is one of the practices that precipitated the last recession. Since then, safeguards have been put in place so that today’s investments in corporate debt are largely held by mutual funds, hedge funds, private equity firms, insurance companies and other financial companies.3
However, some of the signs that can predate a recession appear to be returning. They are worth noting because many individuals have been vigilant about saving at higher rates in their employer-sponsored plans. There’s also been a notable uptick in personal wealth due to higher equity as residential prices have soared in many areas of the country. The following are a few signs worth watching:4
- The Federal Reserve has intimated that financial vulnerabilities are building in the wake of our extended growth period and very low interest rates.
- The corporate sector poses more risks due to reduced spreads and relaxed credit terms, coupled with an increase in corporate debt — the same scenario that preceded the last three recessions.
- Lenders have steadily eased underwriting standards for “leveraged” loans (loans extended to companies that already have considerable debt).
- Outstanding leveraged loans have increased at a double-digit pace over the past five years, to nearly $1.4 trillion.
- Leveraged loans also tend to have variable rates, which makes them more vulnerable in a rising interest rate environment.
Today, U.S. corporate debt is at an all-time high of over 45 percent of gross domestic product, which is higher than levels reached during the dot-com bubble and the housing and credit bubble.5 Furthermore, the trend during this recovery is for corporations to increase share buybacks, dividends and mergers & acquisitions activity rather than invest in long-term organic expansion.6