As US Corporate Debt Soars, Earnings Suggest Dim Outlook on Growth

Kristian Rouz – Capital expenditures on investment and dividend payments in the US corporate sector have been outpacing the total cash flow, or earnings, since mid-2015, stirring worry regarding the sector's lack of profitability. Meanwhile, the total volume of expenses has been above cash flow since mid-2011, resulting in the currently mounting concern that this will result in underinvestment, an accelerated slowdown or a recession. The rising amount of corporate debt in one of the main concerns, and the broader demand-side policies’ failure to revive private sector growth has only added to the economic dismay.

The year-on-year pace of economic expansion has slowed to roughly 1pc in the past quarter, and while the figures for 3Q16 are being prepared for release later this month, the New York Fed has lowered its projections for the quarter. Having previously expected an acceleration in growth to above 3pc annualized, the New York Fed is currently expecting growth of 2.22pc year-on-year, with the growth projection for the year of 2016 lowered to just 1.40pc at best.

The "Nowcast" model, used by the regional regulator, takes multiple broader economic parameters into account, including business sentiment, manufacturing activity, and consumption, among others. The slowdown in economic activity in October and September’s slump in housing starts have resulted in the lowered forecast.

The deceleration in the economy is mainly attributed to mounting disinvestment pressures, even though base interest rates are ultra-accommodative. The overregulated economy is losing momentum, and the lack of funds readily available for investment and reinvestment in the corporate sector is another concern.

"Asset valuations are extreme; returns are poor, the probability of losses is high and the ability to recover any losses quickly is low," Andrew Lapthorne of the bank Société Générale wrote in his note to clients.

With stock prices near their all-time highs, expensive real estate market, and low Treasury yields, opportunities to get a solid return-on-investment are scarce. The ultra-low Fed interest rates are no longer providing much of a stimulus, as most companies are struggling with negative balance sheets, failing to generate profits under the pressure of a heavy burden of indebtedness.

Corporate expenditures have exceeded earnings by a near-record breaking 30pc, according to Société Générale’s data, contributing to rising private sector anxiety. Corporate debt accumulation mirrors the deficit spending of the federal government, which has doubled its debt burden over the past eight years in the hope that it can mend the exhausted model of credit-fueled economic expansion.

"US corporate balance sheets are a major risk going forward," Lapthorne warned. "US corporates are massively overspending."

Subsequently, yield curves on the debt of many corporations have flattened to the displeasure of investors, suggesting austerity measures are on the way, as demonstrated by the recent job cuts at several major banks.

Corporate earnings have been in the negative for five consecutive quarters, while merely two-quarters of negative earnings indicate, historically that a recession is coming. The high corporate debt-to-GDP ratio, rising costs of labor and low yields all underscore the toxic situation in the broader economy.

The situation is becoming further complicated, given that under-leveraged companies are struggling harder to attract capital than those with a higher level of indebtedness. For US non-financials, average the dividend has slumped to 6pc per year, dismally low compared to 13.7pc in 1965, 12.5pc in 1995, and 10.5pc in 2005. Previously, the average corporate non-financial dividend dropped dramatically on several occasions: to 7pc in 1958 (the Eisenhower recession), to 7.75pc in 1974 (the midst of the oil crisis), to 6.50pc in 2001 (the post-dotcom recession), and to 6.25pc in 2009 (the Great Recession).

All that said, the US private non-financial enterprises are now in the worst place they have ever been in recent US economic history, with only the profits generated in the financial and government sectors keeping the macroeconomic indicators above zero.