Behind The Corporate Bond Market's $10.5 Trillion Debt 'Bubble' - YouTube

Underneath the glittery coverage of the stock market.

Stocks, stocks, stocks, stonks, I mean, stocks.

2021 still looks quite positive...

There's a whole other side to public companies

Not for bonds though. The bond market.

It's not as sexy of a subject as stocks are.

Just that shroud of mystery and mystique and complication over the bond market.

The corporate bond market where companies can go to borrow cash.

Now, companies are facing the highest debt levels ever.

More than $10.5 trillion dollars in debt.

The corporate bond market right now is kind of just hanging on by a very precarious string.

These debt levels were massive before the coronavirus pandemic.

Super low interest rates left over from the 2008 financial crisis made it very

easy to borrow money.

The debt market could even lead to the next economic crisis.

We couldn't have predicted in 2018 that a global pandemic would cause the next

recession. But the point is, corporate debt was reaching record levels then, and it's even bigger

now. You asked about corporate debt.

I'm just concerned if that's a bubble that you're watching.

We do. We do watch those things.

This, after the Federal Reserve took extraordinary measures amid the pandemic-induced

recession to buy into corporate bonds.

The high yield market is now at bubble levels.

And, this is not going to end well.

Some of the most influential companies are issuing these IOUs and some of those are

junk bond status, or in other words, the riskiest kind of bonds, like Kraft

Heinz, Ford and Macy's.

How long can we continue to do this run up in debt?

How long can we continue to to live on red ink?

As of the fourth quarter of 2020, there were over 10 trillion,

562 billion dollars in U.S.

corporate debt.

Most of that is made up of bonds.

So, companies can issue stock to raise money and finance all their business dreams,

or companies can borrow the money.

And, when you borrow money, you're indebted to someone, somewhere for that cash.

That leads corporations to issue bonds, corporate bonds.

With interest rates really low, it's very easy and

accessible to issue bonds in today's market.

If I had to put it in terms of analogy, it's like anyone looking to get a mortgage

loan or refinance their really high interest rate loan and maybe refinance something

lower. When you buy a bond, you become the lender.

You're basically saying, "Yep, company, I believe in you.

Here's some money. Go make it happen." And that company says, "Thanks for believing

in us. We'll throw in a little extra to make it worth your while." That's what finance folks

call the coupon. So whatever you pay to buy the bond, which is called the principle, you'll

get back eventually.

Plus that little extra.

Those coupons are paid out to lenders over time, which depends on how long it takes the bond

to mature. It could be in one year, five years or even 30 years.

It's kind of like a long game of Monopoly.

Every time that bondholder passes go, they collect their coupon.

That's why Wall Street calls this fixed income.

Just as consumers have FICO scores, companies also have scores

themself given by independent rating agencies.

When a company has a good credit standing and Wall Street thinks that the company can make their debt

payments, they're called investment grade bonds, then there's the opposite.

If a company looks like they're potentially unable to repay those debts, that's a high-yield

bond, also known as a junk bond.

Corporate health right now as good.

And as long as corporate health stays good, then the state of the debt markets

stays good. When corporate health goes south, the bond market goes south.

The bond market is bigger than the stock market by multiples.

So, when the bond market blows a gasket, the damages are much

worse for the economy.

Here's what's happening now.

In the corporate bond market, we're seeing companies borrow, issue debt fairly

consistently. And one of the reasons why it's not out in the forefront more

is simply because right now the corporate debt picture looks pretty good.

That's because interest rates remain so low and that lowers the cost of borrowing

money. Companies would rather use cheap debt than to dip into their own cash

piles in. The pandemic is only part of the story.

Corporations in the U.S.

have been on a corporate debt accumulation binge for most of the past 10 or

12 years has come as interest rates have stayed low.

This was traced back to really the financial crisis.

Everywhere you look the color is red.

In 2008, the Fed takes their benchmark short-term borrowing rate down to zero.

Companies just decide we're going to go out and take advantage of this.

You see companies being very opportunistic and it's great during

periods like we are now where things are great.

Feels like the economy's starting to pick up.

You have vaccine distributions, but sometimes companies can get reckless.

Sometimes what will happen, these companies do get downgraded and then they cross

over from this bucket from investment grade to the lower quality, high-yield

area. You're either in one of these two buckets.

There's nothing in between.

Right now, there's a ton of companies right at the edge of that investment grade cliff.

So, when bonds are downgraded from investment-grade to high-yield, it almost falls off a cliff,

meaning there's a lot of selling pressure that takes place.

Asset managers can't hold these bonds because it's crossing over.

And so you'll have this unique opportunity set where managers will force out.

There was a big concern about what we call in the bond market, Fallen Angels, which is

basically a company that had been barely investment-grade.

Those companies get downgraded.

And in 2020, rating companies downgraded several of these fallen angel companies

50 companies were downgraded last year alone for over two hundred

billion dollars in debt.

Like Macy's, Ford and Occidental.

Normally, it's a handful of companies that are downgraded each year

with 40 to 50 billion in debt that's downgraded.

So that puts some context, that's a very unusually high number.

Even during the pandemic era, the situation has not

deteriorated anywhere near what some folks in fiscal and

regulatory areas thought.

You've seen relatively significantly fewer defaults

than we expected when the pandemic struck.

The Fed announced that part of its monetary policy actions would include buying up corporate bonds,

which floods the market with more liquidity and keeps the quote too big to fail banks

stable during a time of crisis.

The amount of bonds that the Fed actually purchased was very

small versus what they could, which meant just the Fed coming out and announcing it,

setting it up, doing a little bit, was more validating to the market than the

actual need, desire to buy everything.

Despite trillions and trillions in U.S.

corporate debt. You could say the potential bubble is benign.

For now. None of these things have been a big problem so far, so it tends to make the

market more and more sanguine about this state of corporate debt.

But, there are issues and one of those issues is what happens if things change.

There are a few things that can make this massive amount of debt a problem.

Now, there are a number of factors out in the marketplace right now and in the economy that

could generate higher inflation.

Inflation is basically how much bang you get for your buck.

When prices of goods and services go higher, the purchasing power of a dollar lowers.

If the U.S. economy sees a lot of inflation, or if consumers start spending a lot more, then

interest rates may go up

Which, of course, makes that debt more expensive.

And a lot of people are actually saving tons of cash right now.

That money starts to get put to work.

It creates price pressures in the pipeline as those price pressures get built up.

The Fed's got to come in and combat that and the way they combat that is by raising interest

rates. Even a 100 or 150 basis point interest rate could be,

spell doom for a company that's really living on the edge.

So, what happens if economic conditions continue to deteriorate?

What happens if interest rates start to go up, that interest rates going up is the most, you know, really the most

important issue at this point, because you have what we call zombie companies.

Zombie companies are companies that are drowning in debt, but not so much that they'll default on their loans.

These companies are doing just enough to skate by.

It's like being only able to make interest payments on your credit card bill or on your student loans.

We've got a lot of zombie companies that are still alive that shouldn't be alive right

now. It's actually across the board where you're finding zombie companies.

It could be a problem in the future.

It's a future problem because these companies ultimately put a strain on economic growth

because they're only making interest payments.

They're not investing in their businesses or employees.

Yeah, what's next?

That's a great question.

When you think about all that debt that's being out there in the pipeline.

What if something goes wrong?

What if rates start to go up?

What happens? And it's a daunting thought.

You have companies borrowing money at all time highs.

Can they pay it back?

And so as an investment-grade manager, we're always looking to see which of those companies can't.

Last thing you want is companies just going bankrupt or defaulting.

For now, the Fed isn't going to raise interest rates anytime soon.

You get overconfident and you just think the Fed is not going to raise rates.

Debt is going to stay cheap.

This is sustainable.

This game can go on forever.

Think about playing a game of Jenga, you know, and you just kind of pull that one little thing out there and it's like, OK,

we're still standing and you just keep pulling things out and you never know where that thing is going to get pulled out, where

that's going to bring the whole thing down and everything collapses and it's a bad thing.

When does that happen? I don't know.

But it's something that everybody should be thinking about.