“Believe none of what you hear and half of what you see.”
That’s pretty good advice for investors when it comes to engaging with the financial media. Take the recent coverage of a supposed looming corporate debt crisis, for example. The drumbeat began last fall with headlines like this one on CNBC.com: A $9 trillion corporate debt bomb is ‘bubbling’ in the US economy.
OK, first of all, bombs don’t “bubble.” More importantly, as even this very CNBC article noted, we aren’t necessarily counting down to debt-pocolypse. True, there is a record level of corporate debt in the US. Companies are carrying a $9 trillion debt load, which does create the potential for catastrophe.
Too much debt is a bad thing. But what these scary articles and broadcast segments don’t tell you is that corporate assets are also at an all-time high. Corporate profits are also hitting record highs. US corporations racked up $2.4 trillion in pre-tax profits in 2018, up from a paltry $700 billion in 2000.
Another way to evaluate this issue is to consider the Net debt/EBITDA ratio of US corporations, which is essentially the debt of a company relative to what it is earning. Lower is better in this measurement. Earning 1X your debt is good. If your debt is 5X your earnings, you may be skating on thin ice.
For example, apply this ratio to a couple of homeowners: Bill has a $250k mortgage and makes $250,000 year. That’s a 1:1 Net Debt/EBITDA ratio and everything is cool.
Karen, on the other hand, also has a $250,000 home loan but earns just $50,000. That’s a ticking debt bomb.
America’s large companies, as a group, are like Bill – their debt levels relative to their earnings are very healthy. Their current debt load is about 1.8x their earnings, some of the lowest leverage seen in over a decade. From 2000 through 2007 leading up to the financial crisis large companies were carrying much higher debt loads — 4.5X to 5X earnings.
Banks have become especially prudent. Financial institutions currently have the lowest amount of debt relative to GDP since 1999.
There are risks within the small-cap space, where leverage is at a very high level. Most observers believe the small cap’s debt is manageable so long as the economy remains solid and interests stay in the current range. But if for some reason, rates start to rise, the small-cap universe could be vulnerable.
The steadily improving debt status of US consumers is another argument against a “corporate debt bomb” explosion. Americans currently have the best debt-to-income ratio since 2000. Leading up to the Great Financial Crisis, consumer debt hit 133% relative to income. That number has fallen to 98% since — a 25% drop.
Consumers with less debt are consumers with more money to spend; consumer spending drives corporate profits.
Corporate debt is an issue, for sure. But don’t let the media’s nattering nabobs of negativism derail your long-term investment strategy. They are working the news cycle for clicks and eyeballs. You are playing the much longer, more important game of building the retirement you’ve always dreamed of.
