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Capital Markets

Corp Debt-to-GDP High but Profits Healthy

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August 15, 2018

Moody’s says corporate debt-to-GDP is at its highest level ever but solid earnings underpin

Bond2Corporate debt rose to a record 45.5% of US gross domestic product in Q1 of 2018, according to Moody’s. Meantime the default rate has dropped to 3.4% in June and is expected to drop even lower by 2019. Moody’s says the last time the ratio of corporate debt to GDP was nearly as high today was the second quarter of 2009. And back then, the default rate shot up to a high of 14.7% (in November of 2009).

What does it mean? It could mean a bout of volatility commodity prices for one, says Moody’s. The rating agency notes that the 80s saw oil prices plunge as a high corporate debt-to GDP-ratio and a rising default rate led to a drop in oil prices (vs. dire predictions of a excessively higher crude prices). But since corporate earnings continue to improve in the second half of 2018 and the default rate is muted, it likely means price stability in commodities for the time being.

“Corporate earnings will determine whether the ratio of corporate debt to GDP is excessive,” Moody’s notes. “When profits shrink, the servicing of corporate debt will be challenged by the simultaneous diminution of cash flows, the market value of business assets, and systemic liquidity.”

But again, this is likely not going to happen in 2018. According to FactSet, 80 percent of the S&P 500 companies have posted better-than-expected earnings so far this earnings season and are beating estimates at a highest rate since FactSet began tracking the metric in 2008. Overall, corporate earnings for Q2 have grown by 24 percent thus far, outpacing analysts' initial forecast of 20 percent growth.

“Thus,” says Moody’s, “the current zenith for the ratio of corporate debt to GDP is distinguished from the previous … highs by the ongoing and expected near-term growth for nonfinancial-corporate profits from current production. This approximation of pretax operating profits grew by 4.1% annually during the 12-monthsended March 2018 and is likely to grow by 5% for all of 2018 before slowing to a passable 3% rise in 2019.”

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