By Joseph Zappia, CIMA, CCO/Co-CIO
Sometimes investors overlook the most obvious things. Obvious things can still matter. Looked at from many perspectives, this is an unusually good time to borrow money. “Yields are low” has been a steady cry for years. The alignment of borrowing costs, need, and repayment ability that is evident today supports borrowing versus lending and owning equities over credit.
Let’s start with what it costs to borrow.
Corporate bond yields in Europe are at all-time lows, according to Morgan Stanley, while US corporates haven’t been able to borrow this cheaply since 1955. Mortgage rates, from the US to the Netherlands, are also at historical lows. Even more important, however, is the real cost. When debt funds an asset (a house, CAPEX, infrastructure), it’s likely that the asset’s value, at a minimum, rises with inflation.
This helps explain why deflation is so bad and self-reinforcing: If the value of things falls every year, you should never borrow to buy them, which constricts credit and creates even more deflationary pressure.
That may have been a fear for much of the last decade when austerity and secular stagnation ruled the roost. And it may have been the fear just 15 months ago, with the arrival of COVID-19. But it’s not today. US 10-year inflation expectations (2.4%) are nearly 40bp above the 20-year average (2.0%). This is new and improves the economics of borrowing materially. So much for the great “distressed debt” opportunity.
That better inflation picture also lines up with a better growth outlook. According to Morgan Stanley’s economists, “global growth is now on a higher trend than before COVID-19. Coupled with the inflation picture, the outlook for nominal growth – the key metric for nominal borrowing – is simply much better.”
What about ability to repay?
On access, capital markets are wide open, especially for lower-rated issuers where access is more of an issue. Year-to-date issuance for developed market high yield credit is almost double the average for the last five years.
For banks, surveys from the Fed suggest that lending standards are easing. The sector is now well-capitalized and comfortably passing regulatory stress tests. Both mark a difference from the prior decade. The US Fed is purchasing $40 billion of mortgage-backed securities a month. This government support de-risks bank balance sheets. This is helping the US housing market as well.
But can borrowers afford to take on additional debt?
After all, debt/GDP for many governments is historically high and rising. Debt/EBITDA for corporate borrowers is elevated.
Low yields make high levels of debt affordable, so much so that the US is spending less on debt interest today, with debt/GDP at about 128%, than in 1981, when it was about 31%.
Costs are low versus even recent history, and the ability to borrow has improved.
But is there any need?
This was the dominant fear of the last decade, and a self-fulfilling one: Weak growth deterred investment. Weak investment hampered growth.
Again, there are encouraging signs and key differences from the last decade.
Morgan Stanley economists forecast a ‘red-hot’ CAPEX cycle, as better growth, and prior underinvestment drive capital deepening across the public and private sector. Higher wages should encourage the usual pattern of more investment to increase productivity of existing workers.
And then there’s the planet. If the weather this summer hasn’t convinced us of shifts in the climate, the latest report from the IPCC, the UN’s authority on climate change, should. Since 1970, global surface temperatures have risen faster than in any 50-year period over the last two millennia.
Combating climate change will require enormous investment – US$10 trillion by 2030, according to the IEA’s 2 degrees scenario. But there’s good news. The economics of investment have improved dramatically, with the cost of wind and solar power declining by 70% and 89%, respectively, in the last decade. The case to borrow to finance this has never been more economical.
What’s good for the borrower, of course, is bad for the lender. Given the valuations of credit and the incentives to issue debt, investors may continue to favor equities over credit and government debt.
Morgan Stanley, Cross-Asset Dispatches Global, It’s a Good Time to Borrow Money, August 13, 2021
Morgan Stanley Global and US Economics, Debt Sustainability: r-g Is Key, July 14, 2021
Federal Open Market Committee (FOMC)
This material is for informational purposes only, it is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Opinions expressed herein are based on economic and market conditions at the time this material was written, and do not necessarily reflect the views of LVW Advisors. Economies and markets fluctuate. Actual economic or market events may turn out differently than anticipated. Facts presented have been obtained from sources believed to be reliable.