The Debt Dam Is Beginning To Breach!

Debt is a very useful tool in business. The more leverage (debt) utilized, the higher the returns. This is the reason Corporate America loves it so much. Simply put, it’s a way to amplify both profit and returns. When a company raises capital by issuing stock, the stock value per share is reduced. This is why it has become a much more common practice to use debt, or a combination of debt and equity. By utilizing one of the later options, the company has less equity outstanding. If either debt option is selected, the company must now pay interest on the debt, such that its after-tax profits will be lower, however its earnings per share will be higher and its return on equity also increases. By issuing debt instead of shares, a company can supercharge its return on equity and earnings per share.

But as with anything, too much of a good thing can be very bad. Our national debt is a good example of what not to do. Extra leverage comes with added risk and debt doesn’t just go away. It has to be repaid! Our runaway stock market thrived on cheap Fed money for years. Many companies were leveraged to the max prior to the COVID-19 pandemic. U.S. corporate debt was already at an all-time high, whether you’re considering nominal dollars, or as a percentage of gross domestic product. The 2020 economic downturn has exacerbated an already dangerous situation. Unemployment is back to 2009 levels, COVID-19 continues to rage out of control, and the U.S. GDP suffered its worse period ever in the second quarter of 2020, with a 32.9% drop. The longer the pandemic keeps a drag on global economies, the greater the damage and length of recovery.

The list of well-known companies filing for bankruptcy in 2020 is long and distinguished, but it is just the tip of a very large iceberg. We’re seeing a rapidly growing list of companies being downgraded by Standard & Poor’s (S&P), which is a good indication of what’s to come. 1970 companies were downgraded in the first six months of 2020 and that already breaks the record for any previous YEAR!  The Fed has been providing necessary liquidity, but they literally have their finger in the dam. It’s only a matter of time before the credit market collapses. The most recent Federal Reserve survey reports that 70% of banks are tightening credit, an indication that frequently precedes a soaring default rate. The ability of companies to roll over their debt when it comes due is being limited by this tightening. Without access to new credit, many companies will simply curl up and die.

Over the past year, only 5% of corporate borrowers have defaulted and the long term average is only 3% to 4%, but S&P is forecasting that by next March we may be seeing a high-yield default rate above 12%, a level that would qualify as the highest since the Great Depression. Regardless of election results, our economy is in for a beating and investors had better start getting prepared. The 5% to 15% of precious metals ownership typically recommended is probably woefully short on protection, when considering fortifications necessary to survive the coming economic storm. Call the experts at American Bullion for professional assistance now, at (800) 653-GOLD (4653).