The last time SocGen strategist Andrew Lapthorne commented on the extent of the massive US debt problem, was back in November when the outspoken analyst didn’t hold back as usual, emphasizing “risks associated with highly leveraged US companies, particularly among the smaller capitalisation names” and warning that “US corporate leverage is abnormally high for this stage in the cycle and a handful of cash-rich mega caps are masking significant problems elsewhere.”
Lapthorne calculated that while on average interest cost as a % of EBIT remains very healthy – as one would expect with record low interest rates – “once you peel away the biggest and strongest US companies, the picture is entirely different.” As shown in the chart below, and as Lapthorne notes, “interest coverage for the smallest 50% of US companies is near record lows, at a time when interest costs are extremely depressed and when profits are at peak.”
Five months later, short-term rates have risen by nearly 100bps, and Lapthorne is back with yet another warning, telling Bloomberg that rising “interest rates are already doing damage, people just haven’t noticed.”
He then focused on his favorite topic, the record amount of debt in the system in general, and the US in particular, and said that “leverage in the U.S. is grotesque for this stage of the cycle. At the moment you’ve got peak leverage at peak prices. It’s not like you have to dig deep to find a problem.“
During the Bloomberg interview, Lapthorne explained that while the number-one conversation his bank has with clients right now is about the correlation between bonds and equities, he said that risks to corporate balance sheets is a bigger problem at the moment, particularly in the U.S. and China; the SocGen strategist also said he worries about volatility in debt “because of the impact it can have on the economy, particularly how it weighs on businesses and the job market.”
Ignore the recent bond market stability, Lapthorne said that credit markets would likely get choppier due to triggers like high-profile bankruptcies, such as Toys ‘R’ Us, or if corporate buybacks drop, something we discussed over the weekend as a distinct possibility should rates continue to rise. None other than Goldman Sachs’ chief equity strategist said last Friday that he saw buybacks becoming “less constructive” in 2019.
Of course, regular readers will recall that the Societe General strategist doesn’t see buybacks as a panacea for markets; after all it was Lapthorne who first pointed out in 2015 that all the net debt proceeds this century had gone to repurchasing common stock.
He said companies that announce buybacks but don’t follow through outperform those that do. The average loss from share repurchases is about 5%, Lapthorne estimates. To him, the action of borrowing money to get a short-term boost in earnings-per-share is often motivated by executive compensation in the U.S.
“The performance differentiator in the U.S. stock market has been an aversion to buying companies with bad balance sheets,” Lapthorne said; that differentiator will only become more pronounced as rates rise, sinking deeply indebted companies.
Lapthorne had one more concerns about the direction of the markets as well: “Instead of the usual market driver of economic growth, this bull market has been driven by valuation growth,” Lapthorne said, adding that confidence in asset prices is deteriorating as volatility has risen. This explains events like the February 5 “volocaust” when in the span of just a few hours amid a broad inflation scare, the market had to reprice the absence of central banks propping up stocks, resulting in one of the fastest bear markets on record.