Disagree with you about the debt. Many companies have shifted from a going concern to a "writing's on the wall." Corporate restructuring has become so desensitized by the market but think about what it actually means. These things take time and time always catches up.
WBD is just an example. NCLH today, too. Tomorrow it'll be someone else.
Companies with debt are clearly more volatile because the market realises that earnings have to be much stronger than historically. Companies are running out of time to dilly-dally and debt on the balance sheet will swallow them alive. Even management schmooze is just not working anymore.
When refinancing inevitably occurs, higher interest rates will increase these businesses costs of capital dramatically. If you're a junk bond company and you're accustomed to borrowing at 4.5% and borrowers suddenly want 8.5%... and that's today! You can't really go to the equity markets, either, showing off a vastly imbalanced capital stack.
What if inflation picks up or rates go up again? Everyone knocks on J Powell but I think he's smarter than recent years have shown him to be. He'll increase rates the moment inflation resurges. And inflation has already shown its persistence. It isn't going anywhere. So rate cuts are off the table. Further, in 2022, companies had the ability to pass on costs because consumers were strong. Two years later, is the situation the same?
Maybe the worst is many years out, but it's the opposite of the last 40 years where borrowers could keep refinancing at lower rates. How can you be bullish? What was a tailwind has become a death knell. Unless the debt is backed against something real (i.e certain commodities, certain RE, patents...).
Furthermore, what if junk bond companies begin to struggle to throw off the necessary cash flows resulting in borrowers being more harsh? That's a contagion effect and if everyone shuns lending to bloated empires, they'll all crumble. It's happened in the past. It'd be presumptuous to think that emotions can't go from euphoria to depression in a snap. Too many zombie companies and something has to give. This market's been too nice for too long. An older person told me about the time (not so long ago) he had a 17% mortgage. And people are throwing toys out of the pram at 5%!
Further, higher interest payments = lower returns for equity holders. Shareholders ought to remember exactly where they lie in hierarchy - management owe us nothing! Companies will quickly cut dividends, stop buybacks as earnings fall off to preserve cash. Makes little sense to buy the stocks unless you're sure that cash flows AND earnings will be consistently higher than interest payments. Minimum 2x interest coverage, imo. Any less and you're asking for trouble.
Either way we must remember what Graham once wrote in that in any sell-off that value will be punished just as much as any other stock so debt or no debt there could be trouble.
I want to say "this time is different" but maybe I've got it wrong. I haven't got enough experience to say what may/may not occur here. I just don't see how small caps/micro caps can get hit more when they're already so cheap. |
