Allocation Strategy During The Corporate Debt Hangover

Now take a look at the charts below. Total leverage by U.S. “investment grade” (IG) corporations has catapulted through the proverbial roof. Leverage does not matter as long as companies can service the debt, right? Unfortunately, investment grade interest coverage is back to levels not seen since 2009.

Coverage

If one shifts to corporations on the world stage, the picture becomes more nebulous. Consider the net debt-to-earnings (EBITA) at global companies. This measure looks at the number of years, theoretically speaking, that a company would require to pay obligations back. And right now, according to Standard & Poor’s, net debt-to-EBITA in 2015 at 3.0 was the highest since 2003.

That’s not all. Analysts typically regard a ratio below three as “safe.” With the average global company straddling the fence between safe and not-so-safe, what does that tell investors about the financial health of the world’s corporations?

Debt TO Earnings Ratio

Why should anyone focus on all the debt talk surrounding the world’s corporations? Don’t they always find a way to right their respective ships? Well, for one thing, if a company has money left over after it services its debt obligations, it cannot necessarily expand its business in productive ways, including research, development, human resources acquisition, marketing and so forth. We’ve already seen the most recent reading of the Institute For Supply Management (ISM) Non-Manufacturing Index hit its lowest level since March of 2014 (55.3). That’s not encouraging, even if it shows expansion in the services arena.

In a similar vein, it is highly discouraging to witness carnage in the capital goods arena. It would seem that companies are unwilling and/or do not have the discretionary dollars to invest in tangible assets to produce goods or services such as office buildings, equipment and machinery. Maybe debt is taking a nasty toll after all. (See the chart below.)

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Disclosure: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered ...

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