Is credit the real bubble?

Spurred on by ultra-low interest rates, companies are piling on the debt.

"Talk of bubbles is in the air again," says The Economist and understandably so. The Dow Jones Industrial Average has hit a record high, while demand for new initial public offerings (IPOs) most notably loss-making social-media site Twitter is robust.

US shares trade on a cyclically adjusted price/earnings (Cape) ratio of 25, significantly above their long-term average. Investors are increasingly confident and it's hard to avoid the conclusion that many markets look expensive. But a bubble? Maybe not.

"There is nothing like the same excitement about shares that was seen in the late 1990s; net flows into mutual funds only just turned positive this year CNBC suffered its lowest audience ratings since 2005 in the third quarter." In short, while valuations may be stretched, there is little sign of mania.

But while stock markets might just be given the benefit of the doubt, it's hard to say the same for some other assets. Take corporate credit, says Jeremy Warner in The Daily Telegraph. "With interest rates at rock bottom, lenders are again throwing caution to the wind and lending indiscriminately."

Leveraged loans loans to companies that already carry significant amounts of debt are a greater proportion of new lending than before the global financial crisis. Corporate credit spreads the gap between yields on corporate bonds and supposedly risk-free government bonds are at record lows (in other words, investors aren't demanding much extra yield for taking the extra risk).

Private-equity firms are once again financing deals through high levels of borrowing, while riskier types of debt that offer investors less protection are becoming easier to sell. It's all symptomatic of a "search for yield" that is encouraging "investors to think of what is essentially junk as comparatively risk-free".

So far, this willingness to embrace risk has worked out, says Ralph Atkins in the FT, but that's because "relationships between economic growth, default rates and corporate borrowing costs have been badly distorted".

Normally, when growth is weak, more firms fail. But eurozone default rates have dropped in the past year despite a recession, because low borrowing costs are compensating for falling earnings. "The big question is: what will happen when central-bank policies return to something more like normal?"

Recommended

Just how green is nuclear power?
Energy

Just how green is nuclear power?

Nuclear power is certainly very clean in terms of carbon emissions, but what about the radioactive waste produced as a byproduct? It’s not as much of …
22 Jan 2022
Stockmarket crash: is the “superbubble” heading for a “superbust”?
Stockmarkets

Stockmarket crash: is the “superbubble” heading for a “superbust”?

America's Nasdaq stock index is down by more than 10% after soaring to all-time highs in a "superbubble". Are we about to see a "superbust" stockmarke…
21 Jan 2022
Inflation: now we really have something to worry about
Inflation

Inflation: now we really have something to worry about

We’ve been worrying about a sharp rise in inflation for years, says Merryn Somerset Webb – now, we finally have something to worry about.
21 Jan 2022
Seven cheap defence stocks to buy now
Share tips

Seven cheap defence stocks to buy now

We’ve got used to a world without war between major powers, but that era is coming to an end as Russia threatens Ukraine and China eyes Taiwan. Buy de…
21 Jan 2022

Most Popular

Ask for a pay rise – everyone else is
Inflation

Ask for a pay rise – everyone else is

As inflation bites and the labour market remains tight, many of the nation's employees are asking for a pay rise. Merryn Somerset Webb explains why yo…
17 Jan 2022
Temple Bar’s Ian Lance and Nick Purves: the essence of value investing
Investment strategy

Temple Bar’s Ian Lance and Nick Purves: the essence of value investing

Ian Lance and Nick Purves of the Temple Bar investment trust explain the essence of “value investing” – buying something for less than its intrinsic v…
14 Jan 2022
Interest rates might rise faster than expected – what does that mean for your money?
Global Economy

Interest rates might rise faster than expected – what does that mean for your money?

The idea that the US Federal Reserve could raise interest rates much earlier than anticipated has upset the markets. John Stepek explains why, and wha…
6 Jan 2022