The US stock market has jumped in anticipation of President Elect Donald Trump’s promises of deregulation and lower taxes, but Morningstar anticipates corporates’ humdrum growth prospects continuing, along with a less attractive environment for raising capital.
Over the last several years, corporates have indulged themselves on cheap capital as they waited for the global economy to pick up speed and growth prospects to improve. However, the US economy has remained moribund and much of the rest of the world in worse shape, leaving acquisitions as the primary way for corporates to increase revenues and deploy their oodles of cash.
The Dow Jones Industrial Average’s quick rise since the election, approaching a record 20,000, is a clear indication that Wall Street sees growth picking up under a new political order. Morningstar’s analysts, however, are less sanguine
“On a full year-over-year basis, we’re forecasting 1.9% GDP for 2017, up a bit from our 1.6% projection for 2016 but still anemic,” writes Robert Johnson, director of economic analysis at Morningstar, in a recent report covering the research and investment management firm’s economic outlook.
Mr. Johnson points out that consensus forecasts have routinely overestimated growth over the last few years. He notes that consumer spending resulted in a “nice pop” in 2014 and 2015 as wages moved up noticeably faster than inflation; but that gap began to close in 2016 as energy prices stopped falling. In 2017, he adds, inflation will likely move up faster than currently anticipated, but lower inflation-adjusted wage and income growth will suppress demand.
As a result, corporates may have to continue relying on acquisitions to boost revenues, prolonging their treasury departments’ M&A-related headaches. Companies in sectors such as IT and pharmaceuticals tend to have plenty of cash firepower, but those relying on lenders will likely face a more challenging funding environment.
Morningstar notes that long-term global interest rates have generally been rising, and in the US rates jumped after the presidential election. Meanwhile, investors hungry for yield have pushed corporate credit spreads tighter across all sectors, and “the average spread of the indexes are now much tighter than their long-term averages,” the research firm notes in a recent report titled “Credit market Insights: Global Rates on the Rise.” Nevertheless, while spreads in fourth quarter 2016 tightened on investment-grade corporate bonds—by 10 basis points, according to the Morningstar Corporate Bond Index–that tightening was “overwhelmed” by the 94-basis-point increase in the yield of the 10-year Treasury bond.
Corporate issuers of high-yield debt were more fortunate, since credit spreads on those bonds tighten enough to mitigate the impact of rising rates.
Morningstar notes that interest rates have not risen as quickly in other developed markets, but in Europe and Asia they did manage to squeak “back into positive albeit still abysmally low territory.” The yield on the 10-year German bond, for example, bottomed out at negative 0.19% in July and has since risen to positive 0.27%, while the yield on Japan’s 10-year bond reached a low of negative 0.29% and rests at positive 0.06%.