Cracks in high-yield credit may have only started to emerge, but equity investors have been signaling growing preference for stronger balance sheets throughout the year, amid tightening monetary policies and booming debt issuance.
Global stocks with the lowest debt-to-equity ratios, a measure of balance-sheet strength, are outperforming those with the highest ratios, according to Bloomberg calculations. The data exclude financials, where gearing ratios tend to be higher than in other industries.
“Aversion to highly leveraged companies is increasingly visible; over the last few weeks the beta of bad balance to good balance sheet companies has been negative,” said strategists at Societe Generale SA including Andrew Lapthorne in a recent note. “To put it more simply, one group has been going up whilst the other has been going down.”
In another indication that money managers are showing a clear preference for cash-rich companies, a global strategy betting on highly leveraged companies while shorting the least geared, as measured by net debt to equity ratios, would have lost money for the past 10 months. That’s the longest losing streak since 2010, data compiled by Bloomberg show.
Another case in point: U.S. stocks with strong balance sheets are outperforming those with the weakest financials, with the ratio between the two near the highest in four years, according to a basket of companies compiled by Goldman Sachs Group Inc.
Meanwhile, a record net 23 percent of equity investors reckon corporate balance sheets are over-leveraged, according to a fund-manager survey this month by Bank of America Merrill Lynch.
“Such opinion is highly unusual outside of a recession, and likely reflects the view that buying equities (through share buybacks or M&A) and funding it with debt — a popular strategy since the financial crisis — is no longer creating value for shareholders at these valuation levels,” strategists led by Hans Mikkelsen wrote in a note.
While equity investors are typically slower to punish indebted businesses than their bond counterparts, the latter appear to be catching up.
Investors pulled more than $2 billion from global exchange-traded funds that track high-yield bonds last week as doubts mount about the sustainability of a rally that has compressed spreads to post-crisis lows.
The size of corporate debt burdens in the U.S. and Europe sets the stage for the eventual unraveling of the post-crisis credit cycle, according to Societe Generale strategists. They reckon smaller-capitalized companies are set to underperform their larger peers next year, since the former are more vulnerable to tighter liquidity conditions.
“The threat of slower economic growth and rising rates would put global debt back in the spotlight and have a spiraling effect,” analysts including Klaus Baader wrote in a report this week.