DJ Corporate America Is Ready to Pay Down Its Debt. That's Bad News for Stocks. -- Barrons.com

By Bill Alpert

Corporate debt levels have fixed-income investors worried. But this is a stock market column and all that debt has been great for equities, because it funded acquisitions, dividends, and stock buybacks. Along with a free-spending Fed and an economic recovery, corporate debt helped drive the market's 10-year run.

Now, companies will feel growing pressure to deleverage. Interest rates have risen to 2%, from zero. With investment-grade bonds down nearly 4% this year, money has been leaving taxable-bond funds in search of better-performing alternatives. The stock market may have to continue its run without debt's performance enhancement.

The coming deleveraging has been a theme of Bank of America Merrill Lynch's investment strategist Michael Hartnett, who delights in taking a long view that compares today's market to past events like the Tulip mania or the South Sea Company bubble, not to mention 5,000 years of interest rates. U.S. corporate bond issuance has risen from $1 trillion in 2009 to a projected $13.6 trillion this year, he writes, lifting outstanding corporate debt to nearly $75 trillion. That represents more than 45% of gross domestic product--topping levels reached in the last decade's financial crisis.

Tracking the rise of corporate debt, U.S. stock buybacks rose from $275 billion in 2008, to a projected $4.8 trillion this year, Hartnett notes. Like the market, buybacks have hit all-time highs. But as interest rates rise and profit growth slows, Hartnett predicts a Great Corporate Deleveraging.

Stock buybacks may be losing their punch anyway. Apple (APPL) spent $73 billion repurchasing its stock in the fiscal year ended September 2018, compared with $33 billion in its prior fiscal year. Those share reductions helped boost Apple's reported earnings per share. But the buyback king's shares have slid 20.2% since September's end--dropping 11 percentage points more than the S&P 500. Cisco (CSCO) and Southwest Airlines (LUV) have also enhanced their per-share earnings with buybacks. An exchange-traded fund composed of companies that materially reduce their share counts, the Invesco BuyBack Achievers (PKW), has trailed the market.

Bankers worry that corporate leverage could become a trigger of the next recession. Fed Chairman Jerome Powell has called out nonfinancial corporate debt as something to watch. But Merrill analysts report that corporate borrowing has slowed in recent quarters. Debt levels have eased as a multiple of company cash flows to some 3.4-times earnings before interest, taxes and depreciation. That's down from a recent peak of 3.5-times and compares to a trough of 2.5-times in 2012. Maybe we'll steer clear of the debt cliff.

If companies deliver deleverage, that will help them weather a recession. But it does dilute the rocket fuel that has powered the stock market.

Write to Bill Alpert at william.alpert@barrons.com

(END) Dow Jones Newswires

November 21, 2018 07:59 ET (12:59 GMT)

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