Easy credit conditions, thanks to aggressive monetary policy, was one of the key catalysts that drove the equity bull market over the last decade. No matter how expensive equities got, they were attractively valued when viewed through the lens of bonds. The availability of money to borrow, spend and invest has been a harbinger of equity market risk, as equity investors have historically taken their cue from the bond market. Now, credit conditions have tightened, thanks to the Federal Reserve raising rates and lenders becoming less willing to extend loans, as evidenced by the widening of the 10-year, BBB bond yield relative to the benchmark Treasury.
The linkage between liquidity largess and equity market returns has been particularly acute during the most recent bull market as corporate treasurers used easy money to buy back their shares. We estimate that the S&P 500’s “buyback yield” – the market benefit of taking shares off the market through buybacks – was consistently higher than the market’s dividend yield over the last decade.
The buildup in corporate debt over this period has not gone unnoticed, however. Between 2009 and 2017, non-financial corporate debt outstanding expanded $2.7 trillion to $6.2 trillion, reaching 31 per cent of GDP. Thanks to the dearth of yield, lenders were tripping over themselves to extend credit to corporate borrowers, asking little in terms of a yield premium in return. This debt overhang will need to be rolled over, and tighter credit conditions could take a toll on corporate profit margins as firms are forced to pay up to refinance.