If you’re not keeping an eye on the debt binge in corporate America, it’s time to pay attention, according to three Capital Group investment team veterans. Non-financial corporate borrowing has soared to a record high of $9.95 trillion, or 47% of GDP, as of June 30, 2019, according to the Federal Reserve.
What’s driving this debt deluge? Years of low interest rates, combined with two Federal Reserve rate cuts in 2019, have likely extended the more than 10-year-old U.S. economic expansion, and market returns have been reasonably strong.
Unconventional monetary policy decisions — aided by persistently low inflation — are giving heavily leveraged U.S. companies incentives to continue borrowing.
Much of the debt has been used to fund dividends, share buybacks and acquisitions. In many cases, these actions are helping to inflate reported earnings and share values.
So, what does this mean for companies, investors and the economy? Could this binge on cheap debt be the road to the next recession? Capital Group’s investment team is closely watching three key signals.
1. Not all dividend payments are sustainable
Joyce Gordon, portfolio manager
One important lesson I learned during the global financial crisis in 2008 and 2009 is to avoid companies with a lot of debt this late in the cycle. Companies with significant debt service face a number of challenges. For example, some companies today are issuing debt to buy back shares and pay their dividends, rather than using free cash flow.