Profitability & Leverage of U.S. Stocks
How concerned should investors be about rising interest rates & corporate defaults?
July 2024. Reading Time: 10 Minutes. Author: Nicolas Rabener.
SUMMARY
- U.S. listed companies have become more profitable over the last 20 years
- Corporate leverage has not increased despite the low-interest rate regime
- Interest rate coverage has been declining, but is not an intermediate concern
INTRODUCTION
Calling for the demise of a company, sector, or even country is easy, but getting the timing right is almost impossible. Investors have been betting on the implosion of the Japanese financial system given record levels of public debt and a declining population to finance this for decades, but it has not happened yet.
Many investors speculated that rising interest rates would lead to the end of all sorts of speculative bubbles. And indeed, fixed income investors have taken heavy losses over the last two years, and real estate investors have also started to feel the pain of higher financing costs and lower property valuations.
However, corporate America seems to be doing fine and default rates have not spiked significantly. How can we explain this?
In this research report, we will explore the profitability and leverage of U.S. listed companies.
DEFAULT RATES & INTEREST RATES
Reviewing the default rate of U.S. high yield corporate borrowers in the four decades from 1981 to 2023 highlights that this ranged from 0.6% to 11.8%, but that there does not seem a high correlation to interest rates, which declined almost consistently from 16% to 0%. Intuitively, we would have expected higher default rates when interest rates were in the double digits.
Naturally, rising interest rates do not affect companies immediately as these tend to have financing fixed for multiple years. We therefore shift the default rate by three years into the past, which highlights a slightly better relationship, albeit not a great one.
