- There is a direct link between higher market volatility and turmoil in the corporate-credit market, says Albert Edwards.
- The long-bearish Societe Generale strategist says over-indebted companies are being pushed to the brink of financial disaster by the coronavirus outbreak and the economic slowdown it is likely to cause.
- He blames the Fed for fueling excessive borrowing among non-financial companies.
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The breathtaking volatility that has rocked the stock market for two weeks is rippling through other asset classes — and has spread most notably into credit.
Amid fears that the novel coronavirus will slow the global economy, investors piled into Treasurys and added new life to its 40-year-strong bull market. The scramble for safety sent the yield on the benchmark 10-year note below 1% and to a record low last week Friday.
This milestone and several other big market moves did not escape Albert Edwards, a global strategist at Societe Generale who anticipated the dot-com bust and is well-known for his bearish views.
In light of the coronavirus outbreak, its associated volatility, and a likely economic slowdown, Edwards is warning that the corporate-credit market is poised to experience a wave of defaults.
Many other experts sounded similar alarms before the coronavirus-induced volatility worsened.
In February, a report from the Organisation for Economic Co-operation and Development showed that corporate debt hit a record $13.5 trillion at the end of 2019. Furthermore, it warned that because this debt pile is increasingly long-dated and low in credit quality, the negative effects of an economic downturn on the non-financial corporate sector may be amplified.
Within a month of that report, the threat of an economic downturn became very real, largely due to the supply-chain, travel, and spending disruptions caused by the coronavirus.
"This time around things are much, much worse than 2008, particularly as the whole economy effectively cantilevers off multiple financial market bubbles," Edwards said in a recent client note.
He continued, "When the equity market begins its long descent in the elevator and VIX begins to spike upwards, as it has begun to do in recent days, we would expect corporate bond spreads to eventually explode higher."
Edwards envisions that companies already struggling to generate profits will suffer defaults and bankruptcies if the stock market's woes intensify and the economy slows.
Credit investors are already on notice. The spreads between yields on Treasuries and junk bonds have widened to 475 basis points from 403 since the start of February — the biggest jump since Dec. 2018 — according to the ICE/BofA high yield index.
Although the coronavirus would be the immediate trigger of another crisis, the longer-term blame lies with the Federal Reserve, according to Edwards.
He said the Fed's continual interventions in periods of market turmoil have kept corporate bond spreads low, warded off defaults, and allowed companies to continue borrowing in excess. These over-indebted companies are now the vulnerable to an economic slowdown that hurts their cashflows.
It is worth noting that a new credit crisis may not be as severe as the 2008 disaster. For one, banks are not exposed to the same toxic securities that pervaded the housing market in the 2000s.
Still, the danger to non-financial companies and investors who facilitated their borrowing should not be discounted — and Edwards will be keeping close tabs on it.
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