Expert Commentary

Debt-Deflation Sentiment High

There's evidence that attitude towards debt is changing.

According to the author Anthony Douglas Williams, "Knowledge comes from learning. Wisdom comes from living." Unfortunately, wisdom often comes with the price of knowing how foolish we have been in the past! The old saying, "Take time to fix the roof when the sun is shining," is wise advice. In other words, take advantage of the good times to prepare for the inevitable bad times. That sentiment appears to be growing in capital markets with evidence that investors are increasingly concerned over the high level of corporate debt.

An article in the Financial Times points out that the recent Bank of America Merrill Lynch survey revealed that 50% of respondents would rather see companies using their spare cash to improve their balance sheets rather than use it to invest in new plants or equipment, or even to return it shareholders via dividends. Investors are concerned that companies with high debt levels (such as Verizon, AT&T and AB InBev) are susceptible to downgrades in the event that the economy weakens.

Strikingly, that's the highest level of concern on this survey topic since September 2009 when the global capital markets were still down and out after the savaging of the financial crisis.

We find that particularly interesting because it must be telling us something about sentiment. We don't want to appear like the famous "two-handed economists" but, on the one hand, we could conclude that such a high level of concern reflects deeply bearish sentiment, as it did in September 2009, after which the capital markets continued to recover. On the other hand, it may reflect a trend that is only starting to get going. After all, only half of survey respondents feel that concerned. We can assume that the other half are still quite relaxed.

Thus, the evidence suggests that a relatively high proportion of people want companies to de-leverage and deflate their debt. Social mood, as reflected by the NYSE Composite index, topped out in January 2018 and so the rise in such concern over high debt levels fits with this nascent negative mood trend. According to our Elliott wave analysis that negative trend in mood is set to intensify, and we would not be surprised to see concern over high levels of corporate debt reaching closer to 100% before the economy can finally recover.