The market has been on a wild ride over the past two months, with everything from trade to politics to weak corporate outlooks for the next year sending stocks tumbling lower.
But Lindsey Bell, an investment strategist at CFRA Research, says there’s another massive market risk flying under the radar.
Bell says that corporate debt has risen to untenable levels at a time when the Federal Reserve is expected to raise interest rates at its meeting next week.
“With over $9 trillion in corporate debt on the balance sheets out there, that’s concerning,” Bell said on Tuesday in an interview with CNBC.
The corporate debt to GDP ratio rose to more than 45% at the end of Q2, marking a “new cyclical high,” Bell wrote in a note, something that hasn’t happened in the past three cycles.
Former Fed chair Janet Yellen voiced the same concern on Monday in an interview with New York Times columnist Paul Krugman saying, “Corporate indebtedness is now quite high and I think it’s a danger that if there’s something else that causes a downturn, that high levels of corporate leverage could prolong the downturn and lead to lots of bankruptcies in the non-financial corporate sector.”
Bell said that, to avoid a corporate debt pitfall, investors need to do more extensive research into a company’s financial health.
“What investors really need to do is make sure they’re starting to look at balance sheets and cash flows. Look at those levels of debt and their ability to pay off the interest expense,” Bell said.
Small-cap stocks tend to be more highly leveraged than large-cap stocks, as evidenced by the fact that the Russell 2000—which is made up of 2,000 small cap stocks—is 2.5 times more levered than the S&P 500. And as the Fed continues to raise interest rates, borrowing costs and interest payments on corporate loans will climb right along with it.
Bell also noted that peak earnings growth may also become a major market headwind heading into 2019.
“Right now the consensus estimate is for 7.5 percent earnings growth in 2019 which is a big slowdown from what we’re seeing this year of 23 percent,” she said. “We think we’ll land in about 5 percent when it’s all said and done.”
Heading into 2019, CFRA Research is overweight utilities and energy, though Bell said they are also interested in tech as it has been one of the most beaten down sectors in the last couple of months.
“We still like tech, for one, because we think that especially where the valuations are right now, they’ve come down significantly,” she said. “Software and services is one area that we like. We think that once we get into 2019, semis (semiconductors) might be an area that you can start picking again.”