“Records were shattered on debt, GDP, and leverage”, SocGen’s Stephen Gallagher writes, recapping what will be remembered as one of the most harrowing stretches for the US economy in recorded history.
What comes next is obviously the subject of considerable debate. On one side are the likes of Larry Kudlow who, at least in part because of his current job title, continues to insist that a “V-shape” recovery is all but assured.
On the other side are the “pessimistas”, as Kudlow famously dubbed anyone who was calling for a recession in December of 2007, on the eve of the GFC (note that in the linked article, The National Review has since changed “pessimistas” to just plain “pessimists”, in an amusing attempt at retroactive political correctness). These folks (the pessimists) argue that irrespective of how robust the recovery turns out to be, structural damage, “scarring”, and the legacy of the debt incurred during the pandemic will serve as a drag for years to come.
The figure speaks for itself. But just in case, what you’re looking at above are all-time records for both investment grade and high yield debt issuance for a single year. Junk bonds blew past the old annual mark set in 2012 earlier this month, while blue-chip debt issuance smashed its annual record in August.
While this may not impede the recovery in the near-term, SocGen’s Gallagher cautions that it could weigh over the medium- to longer-term.
“Our forecasts for US GDP growth for 2020 have been among the upper end in peer surveys… yet for 2021, our forecasts are among the weakest”, he writes, before explaining that the bank’s relatively downbeat medium-term outlook is “mostly because of heavy debt overhang on companies”.
What I encourage folks to consider when thinking about this issue isn’t so much normative concerns about whether debt is “good” or “bad” or whether the Fed’s “moral hazard” liability should offend anyone’s delicate sensibilities.
Rather, what’s important is the mechanical (mathematical, deterministic) read-through for businesses who will need to service the debt.
Gallagher makes this explicit. Even after GDP (the denominator) rebounds, leverage will be high. There are four ways to deal with that, Gallagher says. One is the “hard way”, which is to “remain very disciplined on costs and forceful on revenue gains”. That would prioritize productivity instead of employment. Another way is to slash debt by shrinking businesses, which Gallagher notes is “exactly what we don’t want to see happen”.
Speaking of things nobody wants to see happen, a third method is just to throw in the towel and reorganize in bankruptcy. A fourth is government forbearance, which for now just applies to PPP loans, but could in theory be extended.
Ultimately, Gallagher comes back to the inescapable reality. “There is no easy way to reduce such leverage”, he says. While companies can prioritize profit growth and cash flow, SocGen frets that is “likely to slow hiring in 2021 and beyond”.
Don’t tell Larry.