Ballooning non-financial corporate debt could pose a serious risk to global financial stability, RWC Partners has warned.
According to Clark Fenton, portfolio manager, diversified returns, at RWC Partners, the market cycle has reached the ‘over-extended leverage’ phase, where both corporate and consumer debt is growing, with asset valuations high and defaults ticking up.
Fenton said: “As debt builds up, assets can do well but when debt reaches a peak and starts to turn over, asset prices tend to suffer. It’s a cycle that has repeated over time.”
While banks are in a more stable position than during the financial crisis of 2008, Fenton believes non-financial corporates have leveraged up significantly in recent years.
“Non-financial corporate debt to GDP is at an all-time high and higher than in the last crisis. This is where a potential bubble could blow up,” he explained.
BBB-rated debt now accounts for a record proportion of the investment grade market, suggesting that while debt is on the rise, the quality of the debt is deteriorating.
But despite “signs of stress”, equity markets appear to be untroubled, with the US stock market hitting an all-time high. Fenton says the dynamics show how dependent the market is on “easy financial conditions” and there needs to be a continuation of strong measures by central banks to retain momentum.
In response to market conditions, Fenton has positioned his portfolio defensively, with liquidity and capital preservation the leading priorities. He considers both US treasuries and gold as attractive.
As the next stage of the cycle kicks in, Fenton said he will be looking for equities that could benefit if inflation picks up.
He adds: “The idea of being defensive, but not making money out of a crisis is not enough. We are looking to make money for our investors in periods of market drawdown. We’re not a bear-market fund structurally, but we’re looking to make money out of the next bear market.”
