Will Debt Hinder A Recovery?
One of the main concerns that many cautious investors have about investing in the stock market is that the current level of consumer and corporate debt is unsustainable and will likely hinder any
economic recovery. However, the level of private debt in the US is actually more
manageable now than it has been in years. Let me explain and illustrate.
Consumer debt
A combination of low interest rates, tax cuts and continued growth in wages
has enabled consumers to significantly improve their finances. As Alan Greenspan
remarked yesterday, “Nowhere has this process of balance sheet adjustment been
more evident than in the household sector.” In fact, the amount of money that
households spend to service their debt, has declined for the past few years and
is now at pre-equity bubble levels.
Corporate debt
Low interest rates and cost cutting have also helped businesses improve their
balance sheets, which has resulted in a significant narrowing of the spread
between corporate bonds and that of risk-free Treasury note
(
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spread measures the risk premium that the market assigns to corporate issues.
This, in turn, has enabled businesses to refinance their existing debt at lower
levels. As a result, the amount of money that businesses spend to service their
debt as a percent of cash flows now measures 22%–which is 4% lower than what it
was at the beginning of the bear market. Moreover, the amount of
short-term debt as a percent of total debt in the corporate sector is the lowest
it has been in over 40 years. Â
Edward Allen