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Opinion: The Mother of All Recessions May Be Coming

By Sean Williams - Sep 25, 2019 at 6:36AM

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The Fed's loose monetary policy has buoyed the U.S. economy for more than a decade but may soon be its downfall.

Whether you're a novice investor or a seasoned veteran, you're witnessing history right now. For the past 122 months, the U.S. economy has been expanding. Dating back to the early 1860s, which is when relatively accurate record keeping for economic growth and recessions began, this represents the longest period of expansion in history. The previous record was March 1991 through March 2001 (120 months). 

Over the past 122-plus months, long-term investors have flourished. All three of the market's major indexes -- the Dow Jones Industrial Average (^DJI 0.03%), S&P 500 (^GSPC 0.01%), and Nasdaq Composite (^IXIC -0.30%) -- have hit all-time highs, with these indexes effectively quadrupling to quintupling from their Great Recession lows.

The facade of a Federal Reserve building.

Image source: Getty Images.

The Fed has played a big role in buoying the U.S. economy to its record-long expansion

Although there are a number of factors that have helped rally the market and enticed consumers to spend -- consumption makes up about 70% of U.S. gross domestic product (GDP) -- it's the actions of the Federal Reserve that are most often revered.

Both during and following the Great Recession, the Fed wound up enacting multiple rounds of quantitative easing that involved buying mortgage-backed securities and U.S. Treasuries to stabilize a jittery market.

Additionally, the nation's central bank wound up lowering its federal funds target rate to a historic low of 0% to 0.25% in December 2008. It would remain at this level for seven full years. This federal funds rate doesn't directly control interest rates, but it influences other variables that do, effectively, impact the interest that most borrowers pay. The thesis here being that if businesses have access to capital that they can borrow for a low cost, they're liable to expand, hire, and bolster the U.S. economy.

In other words, the Federal Reserve opened the door to borrowing rates that have been historically attractive for quite some time. And even after nine quarter-point (25 basis point) increases in the fed funds rate between December 2015 and the end of 2018, and two subsequent quarter-point reductions in recent months, borrowing rates remain incredibly attractive for businesses and consumers compared to their historic average.

For years, this low-interest-rate strategy has worked marvelously. But the Fed's actions, and President Trump's demands for lower interest rates, could have the U.S. economy headed for the mother of all recessions sooner rather than later.

A neat stack of one hundred dollar bills chained up and locked.

Image source: Getty Images.

Here's why you should be worried

Before I get into the nuts and bolts about why you should be worried, let's get one bit of housekeeping out of the way. Namely, recessions are an inevitable part of the economic cycle.

Because the Fed doesn't have access to real-time data, it's always going to be reacting to economic indicators that are, in some cases, months old. And even when the Fed does act, its monetary policy tools, such as raising or lowering the fed funds rate or buying/selling Treasuries, can take months or more than a year to really have an impact. So, while I point my finger at the Fed, understand that I'm not ignoring the fact that recessions are inevitable.

Now, back to the topic at hand: Why you should be worried.

According to an April-released report from audit, consultancy, and advisory firm Deloitte, corporate borrowing is soaring. While borrowing is a sign of a healthy economy, not everything is roses when you dig into the data.

Between the first quarter of 2011 and the third quarter of 2018, the report notes a significant increase in corporate debt securities (i.e., bonds), relative to traditional loans. Nonfinancial corporate debt grew by 6.3% per quarter year over year, compared to 4.5% for traditional loans. Over a 28.5-year period between Q1 1990 and Q3 2018, the ratio of the value of debt securities to traditional loans more than doubled to 1.9 from 0.9. In short, businesses clearly prefer issuing their own debt than borrowing from a bank. 

A separate report from Forbes in July found that U.S. nonfinancial corporate debt of large companies stood at nearly $10 trillion, or 48% of GDP. That's 52% higher than its previous peak of $6.6 trillion in Q3 2008, which represented 44% of U.S. GDP that year.

In other words, the Fed's loose monetary policy may be encouraging businesses to over-lever themselves. Should the economy turn, certain businesses and industries may be ill-prepared to deal with the consequences of their aggressive borrowing.

A growling bear, with a plunging stock chart in the background.

Image source: Getty Images.

This could impact all industries, as well as major companies

And don't think for a moment that this would be a small-to-medium-sized business concern. Deloitte's analysis finds that between 2010 and 2017, the interest coverage ratio declined, on aggregate, for the top 100 companies in terms of market value. Further, the net debt-to-EBITDA ratio worsened for the top 50 companies by market cap, as well as those in the top 100 to 1,000, between 2010 and 2017. Comparatively, interest coverage and net debt-to-EBITDA improved across the board during the previous two recovery periods (1992-2000 and 2002-2007).

This also isn't solely a one-industry or -sector problem. The Fitch U.S. leveraged loan default index from July shows that more "loans of concern" have been added to the list than removed in six of the past seven months, with retail, telecom, and energy representing some of the more concerning industries. Retail accounted for 18% of the outstanding loans of concern in July.

J.C. Penney (JCPN.Q), for instance, had $1.57 billion in outstanding loans that may struggle to be repaid, according to Fitch. J.C. Penney has struggled to reinvent its image in the wake of online retailers undercutting its pricing, and discount brick-and-mortar retailers like TJX Companies buying brand-name merchandise in bulk and steering customers away from stodgy department stores. A company like J.C. Penney needs capital to adjust its strategy, but simply doesn't have access to it.

Other names mentioned by Fitch that might ring a bell include Frontier Communications, Pier One Imports, and Revlon

You'll note that these are businesses whose situations are already viewed as being dire by Wall Street. But there are other companies not listed by Fitch that I believe could come under fire if there's so much as modest strain put on economic growth.

Not to specifically pick on Ford (F -2.72%), but the automaker has piled on more than $50 billion in debt since the end of 2012, it now sports a debt-to-equity of 431%, and its credit rating was recently downgraded to junk by ratings agency Moody's. More specifically, Ford's financial debt-to-EBITDA is near its highest point since 2009. We've seen via trade war antics that it doesn't take much in the way of external forces to upend Ford's momentum. If and when the corporate debt tide turns, Ford, and many other big-name companies, could find itself in very deep trouble.

A smiling woman looking off into the distance while holding the financial section of the newspaper.

Image source: Getty Images.

Two reasons these corporate debt risks may be overblown

To Yours Truly, corporate debt data suggests trouble is brewing. This is a big reason why I continue to own gold and silver mining stocks, and why I've been hesitant to sell much of any of my safe-haven stocks despite strong rallies in all of them in 2019.

However, optimists may be able to take comfort in two respects.

First of all, naysayers don't exactly have the best track record when calling for a recession. I know I've sounded the alarm a few times over the past decade, and the resilience of the U.S. economy, consumer, and stock market have proven me wrong every time. The thing to remember about the U.S. economy is that it spends far more time expanding than contracting. Sure, you might get a few minutes in the spotlight for having correctly predicted a downdraft in the U.S. economy, but history suggests that it'll be short-lived and followed by a considerably longer period of economic expansion.

This leads to the second point: The stock market tends to increase in value over the long run. Even in instances where the Dow, Nasdaq, and S&P 500 lost half of their value, long-term investors wound up being rewarded. All three indexes are well above their 2007 pre-Great Recession highs, and in many instances, stock market corrections of 10% or more are erased in a matter of weeks or months by a bull market rally.

So, yes, the mother of all recessions may be coming, at least based on the corporate debt data that's available. But that's also not cause to sell everything and hide your cash under the mattress.

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Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
$31,261.90 (0.03%) $8.77
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
$3,901.36 (0.01%) $0.57
NASDAQ Composite Index (Price Return) Stock Quote
NASDAQ Composite Index (Price Return)
$11,354.62 (-0.30%) $-33.88
Ford Motor Company Stock Quote
Ford Motor Company
$12.50 (-2.72%) $0.35
J. C. Penney Company, Inc. Stock Quote
J. C. Penney Company, Inc.

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