Editor's note: Credit is tightening. That's a big problem for a lot of companies... And according to Joel Litman – founder of our corporate affiliate Altimetry – it's a problem for investors, too. In this piece, updated from a July issue of Altimetry Daily Authority, he explains why this could push weaker businesses over the edge... Plus, he shares one step you can take to avoid hidden traps in the markets.
The credit market has seen better days...
Interest rates are rising. Credit continues to tighten. Financing isn't as accessible as it used to be.
Just look at the state of the high-yield ("junk") bond market. These bonds are viewed as much riskier than their investment-grade counterparts. The underlying companies are more likely to default... So they have higher yields as a result.
Defaults in the $1.4 trillion U.S. junk-bond market have risen substantially. Ratings agency Fitch expects junk debt defaults to reach 4.5% of all outstanding U.S. junk debt by the end of this year, up from 2.8% in July.
The Federal Reserve's aggressive rate hikes are putting pressure on riskier companies.
Specifically, weak companies with large debt piles are taking the biggest hit. And the scary part is... the Fed anticipates at least one more hike this year. So the pain likely isn't over yet.
Today, we'll take a closer look at why this is a bad time for risky businesses to be in trouble...
It's not just the bond markets that are closed to borrowers...
Banks aren't rushing to hand out loans, either.
John McClain, a portfolio manager at Brandywine Global Investment Management, said in June that "the credit quality of the loan space is poorer than the bond space."
Reduced access to credit puts companies at higher risk of default, since they can't refinance. That's why some companies that have defaulted before – including Envision Healthcare and mattress retailer Serta Simmons Bedding – did so again this year.
Banks are tightening lending standards rapidly. We can see this by revisiting one of our favorite ways to track credit standards – the Senior Loan Officer Opinion Survey ("SLOOS").
The SLOOS is a quarterly survey conducted by the Federal Reserve. It asks loan officers if their lending rules have tightened, eased, or remained unchanged in the past three months.
In other words, it gauges how eager banks are to provide loans... and how easy it is for firms and individuals to access credit.
The chart below shows the percentage of domestic banks that tightened standards for commercial and industrial (C&I) loans to large- and middle-market firms. As you can see, banks are still tightening faster than at any time since 1990... other than the past four recessions. Take a look...
Banks know that corporations are under a lot of financial strain. So they're choosing not to hand out money.
Companies are built on the backbone of loans and debt...
That's why understanding credit availability is key for investors. If a company's loans are worthless, its equity will be worthless, too. You need to know where these companies are positioned at all times.
Watch out for companies with large exposure to debt that they can't refinance. Some have variable-rate debt that gets more expensive as interest rates rise... So when lending standards tighten and they can't come up with the money, they're at risk of defaulting.
Banks are being strategic today. Given the current market conditions, this seems like a smart move.
At Altimetry, we still think we're looking at a more or less sideways market for the rest of the year. If credit conditions take a nosedive, my forecast could become even more bearish.
Editor's note: Just a few nights ago, Joel walked thousands of online viewers through one of the lowest-risk moneymaking strategies of all time. It's ideal in a crisis like the one he expects for the credit markets... Not only that, but it's the only strategy many of the world's most successful billionaires care about. You can still learn how it works if you missed the event... Watch the replay here.
"Excluding the brief period following the pandemic, we haven't seen credit this tight since right before the last financial crisis," Mike DiBiase says. Bank loans are one reason – but another major source of credit is drying up, too. And it's another factor that could lead to more defaults ahead... Read more here.
"Keep in mind that not every bond carries the same amount of risk," Rob Spivey writes. Creditors are recovering less money on average when companies go bankrupt. But there are still safe opportunities in the bond market – and if investors get more fearful, we'll likely see even better contrarian setups... Learn more here.