Editor's note: This bull market is still in its early stages. But as we've already seen, that doesn't mean we shouldn't expect volatility. Today, Rob Spivey of our corporate affiliate Altimetry is sharing a warning for the economy... and for stocks. In this piece – adapted from a recent issue of Altimetry Daily Authority – he explains why higher interest rates are finally taking a toll on cash-strapped companies... and why the damage could spread in the years to come.
It took two years for the Federal Reserve's rate hikes to kill the economy...
Back in 1947, the central bank started raising interest rates to combat rampant inflation. It wasn't the kind of inflation we suffered in the 1970s... This was driven by the post-war boom.
Soldiers came home from World War II with more cash than they knew what to do with. The national unemployment rate was less than 2%. And manufacturing was shifting back to business as usual.
So demand for goods spiked while supply remained the same... driving inflation way higher.
The Fed had a difficult task ahead. It needed to cool the economy while almost everyone – corporations and households alike – was flush with cash. So it wasn't until 1949 that the Fed's actions officially tipped the U.S. into a recession... And it was a mild one at that.
Higher interest rates had finally eaten away at all the extra cash. It had taken at least 18 months – but by then, companies were no longer able to refinance.
Today's economy mirrors the 1940s postwar economy. And now, the next phase is setting in...
Corporations built up their balance sheets during the pandemic. Most of them paused any unnecessary spending – and benefited from the flood of government stimulus. So when the economy rebounded faster than expected, companies found themselves with more cash than ever before.
But that's no longer the case. A credit crisis is finally looming. And as we'll explain, it has the potential to trigger the next recession...
The Fed's rate hikes are finally starting to take their toll on corporate balance sheets...
Notably, they're threatening debt coverage after 2025. You can see this in the chart below. It shows the number of companies in the S&P 500 Index with enough cash to handle debt coming due in the next three years.
Right now, most companies still have enough cash to cover this year's debt. But when you look at all maturing debt through 2025, the picture isn't so bright...
Compared with 2009, more companies today have cash above their maturing debt... but it's a lot fewer companies than the average over the past 15 years.
That's also a change from May. Just four months ago, nearly 4 out of every 5 companies had more cash than debt coming due in the next year. And the number of firms with enough cash for the next three years was near normal peak levels.
The more companies with enough cash to cover debt, the less risk there is in the market. Today, we have about the same number of those companies as we did in 2018. Any lower, though, and we're getting back to Great Recession territory.
Something has to give. Companies typically refinance their debt roughly one to two years out. So if they want to refinance this 2025 debt, they need to start soon.
We've been saying for a while that refinancing issues could surface somewhere between the end of 2023 and early 2024. This data only reaffirms our view...
The Fed is prepared to keep interest rates high until unemployment rises. That's a bad sign for companies that are running out of cash. It means more and more businesses will struggle to refinance their 2025 debt.
Credit is less available. Meanwhile, valuations are elevated after the market rallied to start the year. Earnings growth no longer looks like it could help push the market higher... Instead, those growth numbers have started shrinking. Overall, the market doesn't have much reason to rise.
If investors get bad news, we could see more volatility in the coming months.
The warning signs are clear. We should expect a repeat of the late 1940s... with a credit crisis and defaults ahead for cash-strapped companies.
So don't think the danger has passed. A recession is likely still ahead.
Editor's note: No matter where the market is headed, you can protect your wealth – and even unearth hidden opportunities. That's why Rob and Altimetry founder Joel Litman are sharing an urgent online briefing tonight at 8 p.m. Eastern time. They'll explain a signal that's flashing "red" right now... and why it means the next three years could be uniquely dangerous for investors. Most important, they'll reveal a little-known way to position yourself for double-digit income – even in a crisis.
It has nothing to do with short selling, gold, options, or anything you've likely considered... So don't miss what they have to say. Sign up to watch tonight's event for free right here.
"The credit market is having a rough year," Rob says. Today, creditors are recovering less money on average when companies default on their debt. That's a big worry for bond investors. But as folks run for the exits, many safe bonds will start trading at major discounts... Read more here.
The COVID-19 pandemic turned working from home into the "new normal" – and tanked office real estate. Now, the poster child for this struggle is on the verge of bankruptcy. And if the company fails, it could send a fresh wave of panic through this part of the market... Learn more here.