How Could Debt Destroy Your Investments?

Despite the Fed buying treasuries and reducing interest rates to nearly zero, the market is still scared. The reason is the combination of a slowdown caused by the virus and huge levels of debt. In this regard, The New York Times writes about how the coronavirus will destroy the economy.

Though the Federal Reserve moved over the weekend to slash rates and buy treasuries, markets around the world fell on Monday anyway. The coronavirus threatens to set off financial contagion in a world economy with very different vulnerabilities than on the eve of the global financial crisis, 12 years ago.

In key ways, the world is now as or more deeply in debt as it was when the last big crisis hit. But the largest and most risky pools of debt have shifted – from households and banks in the United States, which were restrained by regulators after the crisis, to corporations all over the world.

Profits, or at least cash flow, are what have been keeping the market going up. The prospect of national economies screeching to a halt has investors worried about cash flow drying up. But, for many companies, the risk is going out of business. They point out that there are way too many “zombie” companies that are already having trouble coping with their payments. Those in the travel, entertainment, or restaurant sectors are facing a prolonged period of little or no income.

While the problem in 2008 came from household debt and banks, the issue today is companies across the globe that have taken on huge amounts of debt and will not be able to make payments. As many as sixteen percent of US companies fit this description as do ten percent of companies in Europe and China. Companies that went private in order to reduce their exposure to post-2008 regulations are at special risk as many took on lots of debt to buy out shareholders.

How about Stocks like Tesla and Amazon.com?

While we would not be surprised to see companies in the oil and natural gas sector go belly up due to the virus and oil price war, how about market leaders and stars like Amazon.com and Tesla? While Amazon.com may sell more things online during coronavirus dictated lockdowns Tesla does not have this option.

If there end up being massive government bailouts, who will get the money? If credit is shorn up, who gets help paying their debts? For that matter, if they go to negative interest rates, how will that play out with your portfolio?

Investors will be wise to look at the debt levels of the companies in their portfolios and cull out stocks in sectors likely to be weak in the near term and whose debt burdens are excessive.