Growing Corporate Debt
The markets look to finish the week roughly where they started, as headline news continues to drive investor behavior. The news was mixed to a large degree with reports that infections are beginning to rise throughout Europe and the UK, perhaps a sign of things to come in the U.S. as many believe cooler weather in the fall will precipitate a resurgence alongside the flu. On the other hand, the White House signaled it could potentially support a larger federal stimulus package, and it appears Congress is likely to reach an agreement to avoid a government shutdown later this month. The markets moved accordingly depending on which news was released and on which day. We anticipate headline risk will remain high for the period leading up to the election and probably further to the end of the year.
Among the biggest news stories this week was the release of the Federal Reserve’s minutes from its latest meeting. While not a surprise, it formally changed its policy to allow inflation to run above 2% for an extended period of time to make up for extended periods of weak inflation. Also, not a surprise, the Fed now believes it will keep rates at or near 0% until the end of 2023, which is great for borrowers but not so great for savers. Furthermore, the Fed now believes gross domestic product (GDP) will contract -3.7% in 2020, which is better than its previous estimate of -6.5% but expects unemployment will remain elevated for some time. In a nutshell, the Fed is emphatic it is doing all it can to prevent the economy from slipping but in its strongest worded statement makes it clear it is looking to Congress to provide further fiscal stimulus.
In other news, we are seeing two trends that are picking up pace. The first is the number of companies that are taking the opportunity to raise cash in this low interest-rate environment. With already elevated debt loads, many companies are going to the market to bolster their balance sheets. Some are issuing debt with the goal of retiring old debt at lower interest rates, although a not insignificant number are issuing debt to fund operations, which is not a healthy development. Additionally, some companies are going back to the markets to issue new shares of stock, which historically has been viewed negatively by investors. Neither seem to be affecting analysts’ outlooks at the moment, although this is worth keeping an eye as corporate debt grows ever higher. The second trend is the recent increase in mergers and acquisitions. It is unusual to find companies acquiring one another at elevated valuations. Typically, this is something you might see in the middle of a recession before stock prices have rebounded. Yet, with the amount of liquidity these days, it isn’t hard for companies to find the cash to make these mega deals. Examples of this, just this week, are Nvidia acquiring Arm Holdings for $40B, Gilead purchasing Immunomedics for $21B, and Verizon buying Tracfone for $6.25B. Easy money has a way of inflating the proverbial balloon and stretching valuations in the process. Some might argue this is the unintended consequence of the Federal Reserve boosting liquidity and point to history repeating itself.
In closing, I have a bit of company news that might help in these trying times. If you’re like me, the pandemic and now the upcoming election may have you on edge. Perhaps you are even losing sleep? Well, PepsiCo has a new product in the pipeline that can’t come soon enough. Although labeled as a wellness drink, its new drink called Driftwell is aimed at improving sleep quality. The enhanced water drink will contain L-theanine, an amino acid that is also found in green and black teas and some mushrooms. The drink will be available on e-commerce sites in December and will be distributed in grocery stores by Q1 of 2021. Perhaps not soon enough, but I’d be willing to try anything these days. Now you know.
Bruce J. Mason, MBA