U.S. companies are sowing the seeds of the next major financial crisis as they load up on debt to pay for unproductive uses while neglecting to invest in future growth, says Michael Lewitt, an investment manager at Third Friday Group Llc.
“Corporate America spent virtually all its profits and free cash flow on cannibalistic activities rather than investing in new capital projects, research and development and other productive activities,” he writes in the May issue of his Credit Strategist newsletter
. “It now sits on a ticking time bomb of debt that it cannot repay even if interest rates
stay suppressed for years to come.”
The 2008 financial crisis followed a collapse in housing prices that had reached a peak in 2006 on easy credit and rampant speculation. As asset prices deflated, the economy suffered its biggest decline since the Great Depression, financial institutions failed or teetered on the verge of insolvency, the Federal Reserve cut interest rates to record lows and the U.S. government bailed out Corporate America with billions of taxpayer dollars that were partly repaid.
Energy companies that suffered from this year's collapse in oil prices to 13-year lows are the first to confront unpayable debts, with Peabody Energy Corp., SunEdison Inc., Energy XXI Ltd. filing for bankruptcy protection in April. But excessive debt issuance isn’t confined to energy companies, Lewitt says.
“Even if we exclude the oil and gas sector, corporations are still outspending free cash flow by a large margin,” he writes.
Business debt rose by $793 billion in 2015, while total gross private investment rose by $93 billion, according to data cited by Hoisington Investment Management Co.
“This means that the other $700 billion was used for unproductive activities” like stock buybacks, leveraged buyouts, debt-financed M&A, consumption and financial speculation, Lewitt writes. “At the same time, corporate cash flow declined by $224 billion and corporate profits fell by 15 percent to $242.8 billion, their lowest level since the first quarter of 2011.”
He recommends investors reduce their exposure to stocks, which have “the earmarks of a bear market” as valuations remain too high compared with historical levels and those based on generally accepted accounting principles.
“The market is expensive by any measure other than those applied by weak-minded Wall Street analysts who accept phony non-GAAP earnings as truly reflective of corporate performance rather than digging under the surface for the truth,” Lewitt writes. “Investors are well advised to take their unearned gains since February and reduce or hedge their exposures.”
The S&P 500 has risen
about 7 percent since bottoming in February and is up 1.7 percent for the year.
Dividend yields appear to bolster the case for buying stocks now, but other metrics tell a different story, The Wall Street Journal warned.
“Investors who expect bond yields to stay low and dividends to stay (relatively) high are buying stocks not because they are a bargain, but because they look better than bonds. The dividend bolsters the case that there is no alternative to shares,” WSJ.com’s James Mackintosh explains
Low bond yields are sending mixed messages to investors.”First, that the outlook for the world economy is grim, meaning they should expect lower returns on all assets in the future. Second, that government bonds are unappealing, so they should invest in riskier assets instead,” he explains.
"The low returns on the longest-dated bonds are extraordinary: 0.3% on Japan’s 40-year government bond, 0.9% on Germany’s 30-year bund, 2.1% on Britain’s 50-year gilt and 2.6% on the 30-year U.S. Treasury bond," WSJ.com reported.
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