The credit cycle is called a “cycle” because, unlike the business cycle (which the Fed has convinced investors no longer exists), it ‘cycles’. At some point the re-leveraging of the balance sheet – remember more cash on the balance sheet but even morerer debt (as we noted here) – requires risk premia that outweigh even the biggest avalanche of yield-chasing free money. It appears, as Bloomberg’s James Crombie notes, that point may be approaching as yield premiums for U.S. distressed debt hit a five-year high on March 25, according to Bank of America Merrill Lynch.
BAML’s distressed debt index was at a spread of 2,483 basis points — the highest level since March 18, 2009 when it was at a spread of 2,609 basis points.
US corporates saw profit growth slow to almost zero last year and on an EBIT basis it has been flat for some time now. Earnings quality, rather than improving is actually deteriorating, as indicated by the increasing gap between official and pro-forma EPS numbers. As a consequence, following a long period of overspending and in the absence of a strong pick-up in demand, corporates will have to spend less and not more.
Finally, as a consequence of such anemic growth, corporates have been gearing up their balance sheets in an effort to sustain EPS momentum via the continuing use of share buybacks. With markets up substantially in 2013 executing those share buybacks has become increasingly expensive. Little wonder companies have to borrow so much to continue executing them.
This won’t end well…