Less Debt? Less Leverage? It's Practically Un-American!
Last Thursday the Federal Reserve published confirmation of a trend we have been seeing for a few quarters, that is, corporate America is taking on marginally less debt and leverage could be moderating. This trend is practically un-American, as corporate leverage has been ticking up for decades!
Moderating leverage is great for corporate bond investors and is one of the reasons why we still like investment grade corporate bonds this late in the credit cycle. In addition to moderating leverage, corporate bonds are benefiting from higher corporate earnings, very high levels of technical demand (as central banks keep interest rates low) and credit spreads that continue to tighten yet are still relatively attractive compared to other fixed income options. We call it the credit Indian summer–great while it lasts.
It is not quite clear what CFOs are thinking and if the recent moderation of leverage is a durable trend. Current beliefs about the optimal corporate capital structure are still widely influenced by Franco Modigliani (a 1985 Nobel Prize winner), whose groundbreaking work with Merton Miller made the argument that corporations could increase their value by substituting debt for equity. Debt is cheaper than equity and interest payments are tax deductible. This academic endorsement of leverage is, we believe, the underpinning to Michael Milken, the rise of the junk bond markets, private equity and LBOs, and perhaps even to the banking crisis of 2008. Pretty influential for a professor!
This early trend of moderation in leverage may nonetheless have legs. Interest rates around the world have likely bottomed, and even slowly rising rates mixed with high leverage is uncomfortable for CFOs. Also, the corporate bond market now has more BBB than A ratings, and the migration from BBB to BB is usually quite painful. The government’s tax reform proposal may reduce or eliminate the tax deduction for debt. And finally, perhaps stock buybacks and dividend increases are losing favor compared to investments that actually grow revenue and income.
Call us old fashioned, or just plain conservative, but we do think it would be very American to grow the value of companies through investments in productive assets, people and processes all funded with cash flow, rather than just increasing stock values with the use of leverage.
Source: The Wall Street Journal, The Federal Reserve, Bank of America Merrill Lynch
Most Read IRIS Articles of the Week: July 17-21
Here’s a look at the Top 11 Most Viewed Articles of the Week on IRIS.xyz, July 17-21 2017
Click the headline to read the full article. Enjoy!
The fee debate raging across mutual funds has long since seeped into hedge funds. Certainly the direction of travel on hedge fund fees was already downward, as strong industry competition and underwhelming performance have taken their toll. — Yazann Romahi
Equity markets continued their strong run in the second quarter of 2017, thanks to the global economy hitting its stride and registering the fastest level of growth in six years. For the first time since 2011, the U.S. is no longer the only shining star as economic momentum picked up across the globe. — Sonu Varghese
What’s powerful about Smart Beta is that it allows investors to target very specific factors to create an ideal portfolio based on a given asset allocation. — Salvatore Bruno
At almost every financial and insurance conference we’ve attended in the past year, sessions to discuss the Department of Labor (DOL) Fiduciary Rule have been among the most popular. — Merriah Harkins
In researching high growth professional services firms we made an eye-opening discovery. Those firms that did systematic business research on their target client group grew faster and were more profitable. — Michael Kay
We live in a noisy world where wisdom is hard to discern. Here are a dozen financial truths honed from more than three decades of observation. — James E. Wilson
If you keep getting the same actions or responses from your interactions, it is most likely you that is the problem. Stop blaming others for your issues. — Matthew Halloran
Being influential through your verbal and non-verbal communication Monday to Monday® requires deliberate practice. You can’t read how-to’s in a book or rely on your title and comfort level to be influential. — Stacey Hanke
We all search for the least chaotic place to work and think. However, your location could hurt your productivity. Here’s why…. — Jennifer Goldman
You’re supposed to have a single burning passion, right? To feel this incredible drive to do this thing that you love. — Alli Polin
Real innovation, and real disruption, will be concepts and methods which “do new things that make the old things obsolete”. — Tony Vidler
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