How is Debt Adding to Market Uncertainty?
*Seeking Alpha, By Lawrence Fuller, March 16, 2020
”It’s Not The Coronavirus, But The Debt That Will Kill The Economy
The coronavirus pandemic in combination with the collapse in oil prices are the pins that pricked this bubble, but it is a mountain of debt in combination with the excessive valuations that most investors and the Federal Reserve ignored, which will severely damage our economy moving forward. Now, we are faced with a bear market and pending recession.
We are finally taking the bull, although now dead, by the horns with serious efforts to contain the coronavirus in the US. Still, I think market volatility and lower price levels will continue until the sticker shock of a skyrocketing infection count hits its peak. The economy is coming to a screeching halt and consumers will not return to normal spending patterns until schools reopen, people go back to work and life returns to normal. That will be dictated by how successful we are in containment. The longer this process takes, the more damage to the economy and the lower stock prices will fall.
Yet what stands above all else as the most damaging factor in today’s economic and market turmoil is the record levels of debt we have at the corporate and federal government level in combination with $1 trillion deficits. This was instigated by a Federal Reserve that kept interest rates too low for too long, as it pumped unprecedented amounts of liquidity into the financial system. The Fed provided the incentive for corporations to go on a borrowing binge, buying back stock and paying dividends in lieu of capital investment, which was a key factor in inflating stock valuations to historical highs. Business debt now exceeds consumer debt for the first time since 1991.
The amount of high-yield debt outstanding has ballooned to $1.3 trillion. The leveraged loan market, where high-risk companies go to borrow even more, has soared to $1.15 trillion. The downgrades of corporate debt have yet to begin, but they will fall like an avalanche on the corporate bond market just as hundreds of billions are due to mature. Spreads will widen and companies with stretched balance sheets will suffer the consequences. This will ripple through the economy for months to come.
It is impossible to know whether this recession will be shallow or deep and whether it will last six months or much longer. I am certain that there will be no V-shaped recovery. There are too many factors involved that can’t be determined with any accuracy. What we know for certain is that the debt exacerbates the downside significantly. I believe the most likely scenario is a recession that resembles the downturn we had for 8 months from March through November of 2001. The decline in consumer spending was far less dramatic than the collapse in capital spending. This is not another financial crisis.”
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