Do you have any spare change right now?
I hope so, because the world is going to need every penny up for grabs next year.
The world is so saturated in debt that you can expect stock markets to swing wildly when these bills start coming due.
Those days are getting closer every hour.
Take the US budget for example.
This week the Trump administration released their budget proposal for fiscal year 2020 in the United States (this begins 1 October, 2019).
The projected deficit for the US government over this period could be as high as US$1.1 trillion.
That’s just one year we’re talking about here. That’s getting mighty close to the total output of the Australian economy over a 12-month period.
The US budget is now projected to ‘balance’ in 2034. Two years ago Trump said it would be 2028. Yeah right.
Somebody has to finance all this largesse.
Naturally, if investors are buying US government debt (treasuries), that means they’ll have less money to allocate elsewhere.
That could shortly be a problem.
There are going to be a lot of other hands out for cash besides Washington.
Today’s Profit Watch delves into why we keep saying, ‘Be bullish in 2019. Be a little worried about 2020.’
The punchbowl is leaving the party
It’s not just the US government that has debt at an all-time high.
Corporate debt in America is the largest it’s ever been, relative to gross domestic product.
Much of this debt needs to be refinanced over the next two years.
But it’s unlikely to be at the same level of interest rates as those that have prevailed in recent years.
They’re going to be higher.
That’s going to divert more cash flow to debt service.
One effect of this is that it will likely drag down the high level of buybacks currently happening in the American stock market.
That’s not all…
Last year an analyst went on record saying that speculative-grade borrowers had record low levels of cash to service their liabilities.
This could become very important soon.
You see, no debt is created equal. Some borrowers have an ‘investment grade’ rating and some do not.
That’s why we have credit rating agencies.
A company like Apple Inc. [NASDAQ:AAPL] can issue bonds comfortably. It has huge cash levels on hand and massive revenues.
There’s little risk that Apple won’t meet its obligations.
It’s the ‘junk’ bond market that could stress the markets sometime soon.
Analysts at Montgomery Investment Management cited a report recently.
It suggests there could be as much as US$1 trillion in current corporate bonds that could fall from investment grade to junk status as the credit cycle turns.
A lower credit rating implies a higher interest rate to compensate the bond buyer for the additional credit risk.
Point being: lots of American corporates could find themselves in financial distress shortly…at a time when money is harder to come by…
This could ricochet around the world
Let’s go back to the US budget for a moment.
Here’s the kicker: Trump’s latest spending proposal for FY20 assumes the American economy will grow 3% annually over the next decade.
The current growth projection is for 3.2% in 2019 and 3.1% in 2020 and 3% in 2021.
These forecasts are much higher than many independent projections.
Can you see where I’m going here?
If the US economy does not grow at this high rate, the US government deficit could be even higher than the US$1.1 trillion already on the table.
Such an outcome would crowd out even more private borrowers from the credit markets.
Recall that US Fed is withdrawing from the US treasury market.
That means there’s no extra central bank finance available for the US government (unless things change drastically here).
This could push up the yield on the 10-year treasury note. That would take all interest rates higher across the US economy.
The effects of this will show up in China as well.
The Financial Times reported last week that Chinese property developers have issued a record US$19 billion in US dollar debt for the first two months of the year.
New debt issuance exceeds their refinancing needs. That means they’re gearing up even higher than they already are.
The article highlights one company, called Evergrande, carrying nearly US$100 billion in debt.
Some of the interest rates here are already higher than 10% while the terms of the loan are shrinking.
The average length of these new loans are now 2.7 years and down from over 4.
Implication of all this: higher interest rates in America could show up as bankruptcies in China.
The property sector is vital for China — and hence Australia.
Problems here would ricochet in many different directions.
We can’t know exactly when something like this could happen. It may not happen at all.
But the state of the credit markets bears close watching as we get closer to the end of the year.
It’s one reason why I keep saying 2019 is the year to be aggressively buying good stocks with explosive upside in the short-term.
2020 might prove much more difficult to navigate.