We're on the Brink of Catastrophe
Editor's note: Just because things look calm on the surface doesn't mean you should be complacent...
If you dig a little deeper, you'll see that we're getting closer to an economic calamity.
In today's Masters Series – the conclusion of a two-part essay adapted from the November issue of Stansberry's Credit Opportunities – editor Mike DiBiase explains why unprepared investors will could be completely wiped out when disaster strikes in the years ahead...
We're on the Brink of Catastrophe
Today, U.S. corporate debt is at an all-time high...
As you can see in the following chart, it totals nearly $10 trillion right now. That's more than 60% higher than the last financial crisis...
Measured against U.S. gross domestic product ("GDP") – the total value of goods produced and services provided in a single year – corporate debt is the highest it has ever been... Today, corporate debt equals 47% of U.S. GDP. In 2012, it equaled 40% of U.S. GDP.
Companies gorged themselves on debt by taking advantage of the Federal Reserve's low interest rates after the last financial crisis. And many companies have allowed their debt loads to grow to unsustainable levels. But this troubling trend can't go on forever...
Many companies simply can no longer afford their debt. You see, at the same time U.S. corporate debt keeps churning higher, the quality of this debt is deteriorating...
Credit-ratings agency Standard & Poor's (S&P) rates about $7.2 trillion in U.S. corporate bonds today, according to Bloomberg. And roughly 85% ($6.1 trillion) of those bonds are rated as "investment grade."
S&P's ratings for investment-grade debt range from "AAA" (best) to "BBB" (lowest rung of investment-grade debt). Meanwhile, noninvestment-grade debt – the so-called "junk" bonds – is rated from "BB" to "C."
But don't be fooled... "Investment grade" simply doesn't mean what it used to. When you break it down further, you can clearly see why we're on the brink of disaster...
Today, almost $3 trillion of investment-grade debt – about half the $6.1 trillion in total – is rated BBB. In other words... half of all investment-grade debt is teetering on the edge of becoming junk.
That's a significantly higher percentage than at any other time in history...
In the 1990s, BBB-rated debt made up about 25% of all investment-grade debt. In 2000, it was roughly 33%. And just before the last financial crisis, the percentage was around 37%.
The thing is... many of these companies will likely be downgraded to junk status in the months and years ahead. That means the junk-bond market is going to get a lot larger.
Yesterday, we showed that downgrades are on the rise. That's just the beginning...
A convergence of factors will lead to many more downgrades. Companies are facing a pair of problems that will lead to a massive increase in downgrades moving forward...
- A so-called "wall of maturities," and
- High (and increasing) leverage ratios.
We'll start with the so-called "wall of maturities" that's coming...
Back in March 2016, we first alerted our Stansberry's Credit Opportunities subscribers to this concept after Wall Street icon – and current U.S. Secretary of Commerce – Wilbur Ross spoke about it during an interview with cable network CNBC. Through the end of 2023, roughly $3.6 trillion in U.S. corporate bonds are due to mature.
That's nearly 45% of the total debt in bonds outstanding today.
Few companies currently have enough cash in their coffers to pay off their outstanding debt. The vast majority will have to refinance their debt before it comes due. And as you'll see in a minute, many of these companies are more highly leveraged than ever before.
It's going to lead to a massive test of the banks and the corporate-bond market...
Will the banks keep extending credit to companies given the tremendous growth of debt and the deterioration of credit quality? They'll need to decide whether these companies will be able to afford all of their debt. And ultimately, the answer will be a resounding "no"...
You see, according to the Bank for International Settlements – a collection of 60 global central banks – one in six U.S. companies are "zombie firms" right now. That number has increased by six-fold since the mid-1980s.
These zombie firms have annual profits lower than their current interest payments. That means these companies can barely afford to make the interest payments on their debt.
Until this point, the zombie firms have held on because banks continued to refinance their debt as it came due. But as interest rates climb, it'll be "game over" for these zombie firms.
That brings us to the high (and increasing) leverage ratios for U.S. companies...
Leverage is the amount of debt a company owes compared to another financial measurement – like assets, equity, or earnings. By looking at leverage ratios, lenders can figure out whether companies can afford their debt. Companies with higher leverage ratios must pay higher interest rates... that is, if the banks are willing to lend them money at all.
Banks and financial analysts often use the ratio of a company's debt to its earnings before interest, taxes, depreciation, and amortization ("EBITDA"). A debt-to-EBITDA ratio of less than two is good... More than five means a company is highly leveraged.
According to data from Bank of America Merrill Lynch, U.S. companies are more leveraged today than they were before the last financial crisis...
Last year, the average debt-to-EBITDA ratio for U.S. companies was 3.4. It was higher only once over the past 30-plus years – when the ratio soared to 4.0 during the dot-com bubble.
And the lowest-rated companies aren't the only ones in trouble...
According to a 2017 study from investment bank JPMorgan Chase (JPM), the net debt-to-EBITDA ratio for all BBB-rated companies almost doubled – from roughly 1.6 in 2000 to about 3.0 in 2017. The leverage for all investment-grade debt increased from 1.5 to 2.3.
In other words, it isn't just the junk-rated companies using more leverage...
Companies across the entire credit spectrum are more highly leveraged than ever.
With the looming wall of maturities, this situation won't end well... All of this tells us the high-yield-bond market is on the verge of growing much larger. That's a major problem...
You see, many institutional investors – like pension funds, insurance companies, and endowments – have policies that prevent them from investing in anything other than investment-grade debt. So if any BBB-rated bonds in their portfolios are downgraded to junk status, these institutions will have no choice but to unload the bonds immediately.
But the high-yield-bond market doesn't have nearly enough buyers to absorb the massive influx of bonds that we expect to see downgraded to junk in the coming months and years...
Today, the entire high-yield-bond market totals just $1.2 trillion. BBB-rated debt totals $3 trillion today – more than 50% larger than the entire junk-bond market. So as institutions are forced to sell their downgraded bonds, the supply in this corner of the market will soar.
As this new wave of junk debt floods the market, bond prices across the board will plunge... Investors simply aren't going to devote that much of their capital to these riskier bonds.
For unprepared investors, it's becoming clear... We're marching closer to a tragic ending.
We hope we've helped you see where we stand in the credit cycle right now...
We're not going to attempt to predict the next crash in the bond market. No one can do that. But we do know it's getting closer... And it'll likely be much worse this time.
As famed distressed-debt investor Howard Marks reminds us... it isn't important to know exactly when the cycle will turn. But it's incredibly important to know where we are today... and where we are headed. That way, we can tilt the odds in our favor. That's why we're taking Marks' advice today...
It's time to get defensive. We suggest you strongly consider doing the same.
Good investing,
Mike DiBiase
Editor's note: Sooner or later, the credit cycle will turn and the bull market in stocks will run out of gas. The ensuing bear market will be unlike anything we've ever seen before. But if you wait until it's here to start preparing, you'll be too late. You must take precautions now...
That's why we're hosting the Bear Market Survival Event this Wednesday night at 8 p.m. Eastern time. Porter will join investing legend Jim Rogers to go over everything you need to do to survive – and profit – when disaster strikes. Save your spot right here.