Hurtling Towards Financial Armageddon Veneroso Associates April 18, 2018
SocGen shows a doubling in net debt for the S&P 1500 ex financials Figure 1: US Corporate Net Debt Has Exploded and Exceeds Earnings before Interest, Taxes, Depreciation, and Amortization (EBITDA) (in $ billion, S&P 1500 ex-financials)
Federal Reserve data seems to be an outlier Table 2: Growth in Nonfinancial Corporate and Business Debt since 2007Q4 $ billions 2007Q4 2016Q4 Change % Change S&P 1500 ex Financials and GE 1,647 4,089 2,442 148.27 S&P 1500 ex Financials 1,966 4,195 2,229 113.38 Census Bureau: Manufacturing, Wholesale Trade, Retail, and Mining (survey of 11,000 corporations, both public and private) 1,762 3,608 1,846 104.77 S&P s Universe of Nonfinancial Issuers of Debt 3,200 5,800 2,600 81.25 Federal Reserve Flow of Funds: Total Nonfinancial Business Federal Reserve Flow of Funds: Nonfinancial Corporations 10,100 13,435 3,335 33.02 6,325 8,378 2,053 32.46
What would it be if nonfinancial noncorporate debt also grew by 100%? Current flow of funds estimates is the data as currently published in the flow of funds accounts. Estimates based on revised 2007 debt assumes the revised nonfinancial corporate debt at year end 2007 and noncorporate nonfinancial debt at year end 20007 grows 100 percent from 2008 16. Estimates based on original 2007 debt assumes the original data on nonfinancial corporate debt (before a downward revision of $2.35 trillion) and noncorporate nonfinancial debt at year end 2007 grows 100 percent from 2008 16. Estimates for household debt remain as currently estimated by the flow of funds for 2008 16. Current Flow of Funds Estimates Estimates Based on Revised 2007 Debt Estimates Based on Original 2007 Debt ($ billions) Nonfinancial Corporate Debt 2007 YE 6,324.6 6,324.6 7,201.0 Nonfinancial Corporate Debt 2016 YE 8,378.4 12,649.2 14,402.0 % of GDP 44.3% 66.9% 76.2% Nonfinancial Noncorporate Debt 2007 YE 3,775.1 3,775.1 3,774.5 Nonfinancial Noncorporate Debt 2016 YE 5,056.1 7,550.2 7,549.0 Total Business Debt 2016 YE 13,434.5 20,199.4 21,951.0 % of GDP 71.1% 106.8% 116.1% Household Debt 2016 YE 14,673.9 14,673.9 14,673.9 % of GDP 77.6% 77.6% 77.6% Private Nonfinancial Debt 2016 YE 28,108.4 34,873.3 36,624.9 % of GDP 148.7% 184.5% 193.7% Source: Federal Reserve, Veneroso Associates calculations
Hy was right to be concerned that successive government bailouts would lead to greater risk taking and financial fragility Private Nonfinancial Debt (% of GDP) 150.0% 165.3% 175.3% 179.9% 187.0% 197.0% 122.5% 80.0% 99.0% 54.0% 1929 1952 1962 1983 1990 Q4 2007 Q4 (1) 2007 Q4 (2) 2016 Q4 (1) 2016 Q4 (2) 2016 Q4 (3) Source: Federal Reserve, Veneroso Associates calculations 1929 Irving Fisher Booms and Depressions 1952, 1962, 1983, 1990 Q4, 2007 Q4 (1) Actual Flow of Funds data 2007 Q4 (2) Adds Andrew Smithers estimate of off balance sheet debt (10% of GDP) 2016 Q4 (1) Assumes nonfinancial corporate debt grows 104% from 2007 Q4 and nonfinancial noncorporate debt grows 69% 2016 Q4 (2) Assumes total nonfinancial business debt grows 104% from 2007 Q4 2016 Q4 (3) Adds 10% of GDP for off balance sheet debt
Deleveraging Cycles: Private Debt to GDP ratio of 160% seems to be the Red Alert zone Deleveraging Cycles in Selected Economies Private Debt/ GDP at t0 Deleveraging (% of GDP) Duration (Years) Advanced Economies Belgium (2001) 179 20 5 Canada (1992) 150 12 3 Canada (1997) 151 17 8 Denmark (1988) 162 32 10 Finland (1992) 167 47 9 Ireland (1999) 150 33 5 Japan (1994) 221 37 11 Norway (1988) 167 44 7 Norway (1998) 159 5 3 Portugal (1983) 157 63 7 Portugal (2001) 184 16 4 Sweden (1990) 167 44 7 Sweden (2001) 180 17 4 U.S. (1988) 127 18 10 Emerging Economies Korea (1997) 170 44 8 Thailand (1997) 182 74 5 Source: IMF Working Paper, Private Sector Deleveraging and Growth Following Busts, Sally Chen et al, Feb. 2015
The number of economies in the Red Alert zone is alarming Countries with Private Non Financial Debt > 160% of GDP (% of GDP) Credit to the Household Sector Credit to Non Financial Corporations Total Advanced Economies Australia 121.9 77.5 199.4 Belgium 59.8 163.4 223.2 Canada 100.5 116.0 216.5 Switzerland 127.5 85.9 213.4 Denmark 117.2 100.5 217.7 Spain 63.2 100.0 163.2 Finland 66.9 114.1 181.0 France 58.1 133.7 191.8 Ireland 49.9 215.3 265.2 Netherlands 106.8 121.1 227.9 Norway 101.6 148.5 250.1 New Zealand 94.5 82.0 176.5 Portugal 70.8 110.1 180.9 Sweden 85.9 146.5 232.4 Emerging Economies China 46.8 163.4 210.2 Korea 93.8 100.1 193.9 Singapore 60.7 121.0 181.7 Source: BIS
IMF and BIS show the same decline in interest coverage Figure 10: US Interest Coverage Ratio, BIS 8.00 Figure 11: Interest Coverage Ratios By Firm Size, IMF 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: BIS Source: IMF
and Bianco Research for the S&P 1500 * Zombies defined as companies whose interest expense is greater than their 3 year average EBIT
The Rise of the Zombies is not limited to the U.S. It is global. Here is a 14 country composite from the BIS Figure 16: Zombie Firms on the Rise and Surviving for Longer Claudio Borio, A blind spot in today s macroeconomics BIS IMF OECD Joint Conference on Weak productivity: the role of financial factors and policies 10 11 January 2018
Long Term Zombie Trend: Share of public companies with losses up more than 5X in 5 decades Source: Baruch Lev, Philip Bardes Professor of Accounting and Finance at the Stern School of Business, NYU
Why is private nonfinancial corporate debt so high? It is not excessive investment 6% Net Nonresidential Investment 1929 2016 (% of GDP) 4% 2% 0% 2% 4% 6% 1929 1933 1937 1941 1945 1949 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013 Source: BEA
.but rather a large and sustained corporate bid for equities 2.00% Net Corporate Issuance of Equity 1951 Q4 2017 Q3 (% of GDP) 1.00% 0.00% 1.00% 2.00% 3.00% 4.00% 5.00% 6.00% 7.00% 8.00% 1951Q4 1953Q4 1955Q4 1957Q4 1959Q4 1961Q4 1963Q4 1965Q4 1967Q4 1969Q4 1971Q4 1973Q4 1975Q4 1977Q4 1979Q4 1981Q4 1983Q4 1985Q4 1987Q4 1989Q4 1991Q4 1993Q4 1995Q4 1997Q4 1999Q4 2001Q4 2003Q4 2005Q4 2007Q4 2009Q4 2011Q4 2013Q4 2015Q4 % OF GDP Source: Federal Reserve, BEA
0 5 10 15 20 25 30 35 40 45 50 Jan 20 Apr 22 Jul 24 Oct 26 Jan 29 Apr 31 Jul 33 Oct 35 Jan 38 Apr 40 Jul 42 Oct 44 Jan 47 Apr 49 Jul 51 Oct 53 Jan 56 Apr 58 Jul 60 Oct 62 Jan 65 Apr 67 Jul 69 Oct 71 Jan 74 Apr 76 Jul 78 Oct 80 Jan 83 Apr 85 Jul 87 Oct 89 Jan 92 Apr 94 Jul 96 Oct 98 Jan 01 Apr 03 Jul 05 Oct 07 Jan 10 Apr 12 Jul 14 Oct 16 Shiller CAPE Source: Robert Shiller Online Data
35 30 25 20 15 10 5 Multiple Oct 26 Dec 26 Feb 27 Apr 27 Jun 27 Aug 27 Oct 27 Dec 27 Feb 28 Apr 28 Jun 28 Aug 28 Oct 28 Dec 28 Feb 29 Apr 29 Jun 29 Aug 29 Oct 29 Source: Robert Shiller Online Data 1929 Valuations LTM PE Shiller CAPE
24 22 20 18 16 14 12 10 Nov 58 Multiple Jan 59 Mar 59 May 59 Jul 59 Sep 59 Nov 59 Jan 60 Mar 60 May 60 Jul 60 Sep 60 Nov 60 Jan 61 Mar 61 May 61 Jul 61 Sep 61 Nov 61 Jan 62 Mar 62 May 62 Jul 62 Sep 62 Source: Robert Shiller Online Data 1962 Valuations LTM PE Shiller Cape
23 21 19 17 15 13 11 9 7 1987 Valuations 5 Aug 84 Nov 84 Feb 85 May 85 Aug 85 Nov 85 Feb 86 May 86 Aug 86 Nov 86 Feb 87 May 87 Aug 87 Nov 87 Feb 88 May 88 Aug 88 Nov 88 Source: Robert Shiller Online Data LTM PE Shiller CAPE
Apr 96 Jul 96 Oct 96 Jan 97 Apr 97 Jul 97 Oct 97 Jan 98 Apr 98 Jul 98 Oct 98 Jan 99 Apr 99 Jul 99 Oct 99 Jan 00 Apr 00 Jul 00 Oct 00 50 45 40 35 30 25 20 15 10 2000 Valuations LTM PE Shiller CAPE Multiple
29 27 25 23 21 19 17 15 Jan 05 Mar 05 May 05 Jul 05 Sep 05 Nov 05 Jan 06 Mar 06 May 06 Jul 06 Sep 06 Nov 06 Jan 07 Mar 07 May 07 Jul 07 Sep 07 Nov 07 Jan 08 Mar 08 May 08 Source: Robert Shiller Online Data 2007 Valuations LTM PE Shiller CAPE
35 30 25 20 15 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12 Oct 12 Jan 13 Apr 13 Jul 13 Oct 13 Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16 Jan 17 Apr 17 Jul 17 Oct 17 Source: Robert Shiller Online Data Current Market Valuations (through Dec. 2017) LTM PE Shiller CAPE