The recent rise in corporate profits will not be enough to offset the risks associated with global companies’ high debt levels, credit ratings agency S&P Global Ratings said in a report.
The report will undermine investor hopes that a boost to earnings from the U.S. tax overhaul will help support lofty stock valuations and offset concerns over rising bond yields and the pace of Federal Reserve rate hikes.
“When debt is this steep and default rates are low, something’s gotta give,” said S&P Global Ratings analyst Terry Chan, adding that high leverage means a greater sensitivity to higher funding costs and reduced access to financing.
“A material repricing in bond markets or faster-than-expected normalization in money market rates could impact credit profiles, triggering the next default cycle.”
Global financial markets performed well in 2017 but both bond and equity markets turned volatile in late January.
On Monday European indices opened lower and bond yields rose as resurgent U.S. inflation raised the possibility central banks would tighten policy more aggressively than had been expected.
Earnings season is in full swing, and with half of S&P 500 companies .SPX still to report fourth-quarter results and potentially give guidance on 2018, profit estimates are likely to increase further.
But S&P warned that improved performance may not offset worries about rising interest rates because corporate debt is high and increasing.
Ten years on from the global financial crisis, S&P warned that corporate leverage is worse, not better, having “exploded” on the back of unprecedented monetary stimulus.
S&P estimates that 37 percent of corporate entities, based on a global sample of 13,000, were highly indebted in 2017. It said this was a five point increase on 2007 when the global financial crisis was beginning.
S&P, which agreed to pay $1.5 billion to resolve a collection of lawsuits over its ratings on mortgage securities that soured in the run-up to the financial crisis, also said global earnings growth has caught up with debt growth since 2016, having lagged in prior years.
China, the ratings agency said, was the main driver of leverage growth in 2007-2017 and represented the largest leverage risk. With a debt burden of $18.9 trillion, the world’s second largest economy makes up 28 percent of the world’s total.
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