UBS AM: Does corporate America have a debt problem?

Highlights

– US corporate debt excluding Financials has risen to levels of GDP previously associated with US recessions, while a number of key leverage ratios paint a similarly negative picture. We assess the risks and their implications.

– A 300% rise in outstanding Investment Grade (IG) BBB over the past decade warrants close attention. But in our view, the bigger threat lies in US leveraged loans, where the value of debt to increasingly poor quality borrowers has soared while lender protections have diminished.

– Overall our view is that US corporate balance sheets are in stretched territory, but in aggregate not dangerously so given our base case for growth and policy rates.

– Crucially for the US economy, consumer debt is more important than corporate debt; it is hard for us to see US demand  growth collapsing given continued wage growth, a robust labor market and the healthy state of US household finances.

– Key takeaway is that high corporate leverage increases economic ‘tail’ risks should growth slow more than we expect.

– Already fully priced? After derating of US equities and widening of credit spreads since early October, US risk assets do not look significantly mispriced on a short-term basis.

– Nonetheless, macro uncertainty, debt refinancing wall, downgrade risk, and lower EPS growth are likely to weigh on US credit spreads and equity PE multiples over the medium term; alongside higher volatility, this is the new normal.

– Cooling demand impulse, low inflation, tightening financial conditions and US

debt backdrop are all part of why we believe the Fed is close to the top of the rate tightening cycle and that USD will weaken over the medium term.

– From a multi asset perspective, current risk/reward more attractive away from US assets on a tactical basis:

• In credit, we prefer local currency emerging market (EM) debt to US IG or high yield (HY), but expect US credit to offer plenty of opportunities as the cycle matures
  
• In equities, high leverage and still expensive relative equity valuations in the US are key drivers to our preference for ex-US equities; EM and Japan are our favored markets
  
• Cross asset: underweight US HY may be a potentially effective hedge to overweight equities in multi asset portfolios
  

Download the full insight here.