Global sales of new corporate debt across all currencies have reached the equivalent of $2.44 trillion in 2019, already a new annual record. Investors desperate for yield have been eager buyers, fueling a rally in bond prices, but they could get burned in 2020 as several forces threaten to hammer returns on these now richly-valued assets. “The low hanging fruits are gone after a year of strong rally,” Angus Hui, head of Asian and emerging market credit at Schroder Investment Management in Hong Kong, told Bloomberg .
The unresolved U.S.-China trade conflict is just one of several major risks that could weigh on bond prices in 2020. Even if a phase one trade deal is signed, the U.S. and China still must resolve a long list of thorny issues. With respect to equities, Morgan Stanley observes that "international markets...are arguably more levered to a relief from trade pressures...than the U.S." The potential upshot for bondholders is that, to the extent that continued trade tensions crimp corporate profits, servicing that new mountain of debt may become problematic.
- Global issuance of new corporate debt has set a record in 2019.
- Demand from yield-hungry investors has pushed up bond values.
- In the U.S., non-financial corporate debt is a record share of GDP.
- A continued rally in bond prices seems unlikely for 2020.
Significance For Investors
Apart from trade-related issues, any other developments that impair the ability of companies, especially those with weak credit ratings, to generate the earnings necessary to meet their new obligations would threaten bond valuations. Additionally, the refinancing of old debt may become more costly. That's because central banks are unlikely to continue cutting interest rates, should an apparent uptick in global economic growth continue. Meanwhile, geopolitical developments, such as North Korea's resumption of missile tests, may add to uncertainty and unease in the markets.
In the U.S. alone, the total debt load of non-financial companies reached $9.5 trillion in Q2 2019, up by $1.2 trillion in the past two years, The Wall Street Journal reports. Relative to GDP, this was a record 47%. In the face of weak corporate profit growth, this is a matter of increasing concern.
Jesse Edgerton, an economist with JPMorgan Chase, calculates that the debt/EBITDA ratio for non-financial U.S. companies was 2.24 in Q2 2019, per the same report. He notes that this is higher than where it was before the last recession, and nearing its value before the two preceding recessions. On the other hand, the yields on investment grade corporate debt are at their lowest since the 1950s, and interest coverage ratios are roughly in line with their averages over the past 25 years, Edgerton adds.
Michael Ryan, an associate director at global information provider IHS Markit, believes that fears of a dangerous bubble in U.S. corporate debt are overstated. “A supply-side financial analysis reveals the macro-financial picture looks adequately contained, with liquidity, interest expenses, and debt coverage all within reasonable levels,” he observed in a report quoted by MarketWatch . “The system remains secure, reinforced by high corporate proﬁtability, exceptional employment conditions, low interest rates (now falling), and tame inﬂationary pressures,” Ryan added.
But others see sizable risk. “Valuations are tight in parts of the [bond] market, meaning there is not much margin for error,” Craig MacDonald, global head of fixed income at Aberdeen Standard Investments, indicated to Bloomberg. Looking ahead, he anticipates “fairly muted positive returns, if you miss the problem credits, rather than the very strong returns of this year."