Lay Down, Roll Over and Be Dead

zombies

Adverse market conditions.

The final season of a long-running zombie drama treats the undead as little more than scary scenery. Alarming, but hardly a real threat. That could be a big mistake. The Walking Whatnow? No, no. I’m talking about the corporate bond market.

November was arguably the worst month for bonds since 1994. Volatility was up, junk and investment grade sectors sold off, and the yield curve flattened to a bearish extent not seen since 2007. The (once) market-darling investment-grade bond ETF, LQD, is now down 5.3 percent year to date. The TLT long-term Treasury ETF is down 3.2 percent on the month.  

Yes, Jay Powell is reportedly getting the vapors about taking away Donald Trump’s punchbowl, but the market is sure rates will rise on the 19th nonetheless, and the Fed boss has cannily announced that he will give a press briefing after every FOMC meeting going forward – meaning that the committee will have a lot more flexibility about when it changes rates. (Now it does so only at the meetings that feature press conferences.)

Well, so what. Rates are still low, employment and inflation numbers look good. But take a look at the massive increase in business debt in recent years – it is now $32 trillion, over three times the size of the mortgage debt that almost sank the global economy in 2007-08.

As rates rise, and a lot of that debt needs to be refinanced, some of those zombie companies that have survived on the “accommodative” nature of the junk markets in recent years are going to be in trouble. Suddenly, cash flow negative starlets like Tesla and Netflix, which have to borrow to keep the lights on, might lose their luster. And market leaders that have done really, really stupid things, like Apple, which borrowed $150 billion to buy back stock, could rue their fates when it comes time to refinance.

That may be soonish. Most fixed rate corporate debt has a maturity around five years; companies have been on a debt binge for five or more years, hence talk today of the coming fearsome “wall of maturities”. In May, Bloomberg estimated that $4 trillion would have to be refinanced in the next five years. More recently, BNP said S&P 500 companies alone have $1.6 trillion to refinance over the next three years – nearly 4.5 times as much as they had to refinance going into the financial crisis in 2007.

As market watchers shriek in horror as GE, with its $135 billion in debt, makes its shambolic way down the credit curve, other zombies are queuing up at the door. Time for investors to keep their, uh, brains about them.

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