US Stocks Soar as Credit Dynamics Erode

Last weekend I wrote,

It has been a fascination to see global stocks race back to old highs in the face of a stream of bad news. It seems that all it takes for this to happen is for a connected media personality to whisper that the FED won’t be raising rates. Such whisper would then spike the proverbial stock market punch bowl.

It’s as if all bad news will have little bearing not only on valuations but on debt, liquidity and access to credit.

Monetary cocaine has not only been very addictive it works well to lobotomize reason.

Justin Spittler at the Casey Research has a dandy elaboration of the festering bad news on the credit front which continues to gnaw at the core of the US economy and US stocks (bold mine)

-Downgrades to corporate credit ratings are at a six-year high...

A credit rating measures a borrower’s financial health. A company with a low credit rating will often struggle to repay debt.

Credit rating agencies lower a company’s rating when they think the company’s financial health is getting worse. So far this year, there have been more downgrades than in any year since the Great Recession. The Wall Street Journal explains:

Standard & Poor’s Ratings Services downgraded U.S. companies 297 times in the first nine months of the year, the most downgrades since 2009…with just 172 upgrades.

Energy and commodity companies make up a large slice of these downgrades. Last week, Business Wire said that energy and commodity companies accounted for 40% of the downgrades during the third quarter.

Casey readers know the Bloomberg Commodity Index, which tracks 22 different commodities (including oil and natural gas), recently hit its lowest point since 1999. The recent crash in energy prices is a big reason why. Oil is currently down 55% from its 2014 high. And natural gas is down 61%.

Weak commodity prices are translating into dramatically lower profits for many energy and commodity companies. This is a big reason for the recent credit-rating downgrades in the sector.

Ratings agencies have also downgraded several big companies outside of the energy sector…

Standard & Poor’s cut Mattel’s (MAT) credit rating in January. S&P is concerned the toymaker is losing market share. And in March, Moody’s downgraded McDonald’s (MCD) after the fast food giant announced plans to borrow a lot of money to pay shareholders.

-U.S. companies have been on a seven-year borrowing binge...

Casey readers know the Federal Reserve dropped its key interest rate to effectively zero in 2008…and left it there. The past seven years of incredibly low interest rates have allowed for all kinds of reckless borrowing.

U.S. companies have issued $9.3 trillion in new debt since the financial crisis. That includes $1.4 trillion in bonds last year, according to the Securities Industry and Financial Markets Association. This was an all-time high, but the record probably won’t hold for long…

Through September of this year, U.S. corporations had already issued $1.2 trillion in bonds. That’s an 8.4% increase over the same period last year.

This excessive amount of debt is hurting U.S. companies. Last week, The Wall Street Journal said the balance sheets of big U.S. companies are weaker than they were before the 2007-8 financial crisis.

According to one metric, the ratio of debt to earnings before interest, taxes, depreciation and amortization [Ebitda] for companies that carry investment-grade ratings, meaning triple-B-minus or above, was 2.29 times in the second quarter. That’s higher than the 1.91 times in June 2007, just before the crisis, according to figures from Morgan Stanley.

-U.S. companies are also paying out more than they earn...

Last year, companies in the S&P 500 spent 95% of their profits on share buybacks and dividends. That figure hit 104% in the first quarter of 2015, according to Bloomberg Business.

Bloomberg Business also says the last time this happened was just months before the 2008 financial crisis hit.

Shareholder payouts previously rose above 100 percent of operating earnings in the second quarter of 2007. Two quarters later, the figure peaked at 156.5 percent of profit -- and the bull market ended.

This means companies are giving cash to shareholders instead of using the cash to grow their businesses. Every dollar a company spends on dividends and share buybacks is a dollar it doesn’t spend on research and development, new factories, equipment, etc.

-Now corporate profits are falling too...

Earnings-per-share for companies in the S&P 500 fell 16% during the second quarter, according to Standard & Poor’s. It was the biggest drop since 2009.

Last month, Reuters said investors should prepare for another ugly earnings season.

Forecasts for third-quarter S&P 500 earnings now call for a 3.9 percent decline from a year ago, based on Thomson Reuters data, with half of the S&P sectors estimated to post lower profits...

Expectations for future quarters are falling as well. A rolling 12-month forward earnings-per-share forecast now stands near negative 2 percent, the lowest since late 2009...

But even as earnings fall, large U.S. companies are still paying out record amounts of cash to shareholders, according to Bloomberg Business.

In the second quarter, the most creditworthy companies posted declining earnings before interest, taxes, depreciation and amortization. Yet they returned 35 percent of those earnings to shareholders, according to JPMorgan.

That’s kept their cash-payout ratio -- how much money they give to shareholders relative to Ebitda -- steady at a 15-year high.

Chart from Zero Hedge

-Falling profits are making it hard for companies to pay off debt…

In June, Fortune wrote:

According to credit rating agency Standard & Poor’s, 52 companies have defaulted on their debt in the first six months of this year. That’s more than double the number of companies that missed interest payments in the first half of 2014, and it’s close to eclipsing the 60 companies that defaulted in all of 2014. It is also the highest pace of defaults since 2009.

For many companies today, almost every dollar of earnings goes towards paying off debt. For example, the U.S. Energy Information Administration reports that onshore oil producers use 83 cents of every dollar they generate to pay debt. This has created a very fragile situation. The stocks of companies with big debts often fall the hardest during an economic slowdown.

This has created a very fragile situation. The stocks of companies with big debts often fall the hardest during an economic slowdown.

It’s interesting to see how central banking monetary narcotics have spawned and magnified what seems as a parallel universe. How long will central banking free lunch last?