What ever happened to “Six Sigma”? GE was one of the most beloved and hyped S&P 500 stocks during the late-nineties Bubble Era. With “visionary” Jack Welch at the helm, GE was being transformed into a New Age industrial powerhouse – epitomizing the greater revolution of the U.S. economy into a technology and services juggernaut.
GE evolved into a major financial services conglomerate, riding the multi-decade wave of easy high-powered contemporary finance and central bank backstops. GE Capital assets came to surpass $630 billion, providing the majority of GE earnings. Wall Street was ecstatic – and loath to question anything. GE certainly had few rivals when it came to robust and reliable earnings growth. Street analysts could easily model quarterly EPS (earnings per share) growth, and GE would predictably beat estimates – like clockwork. Bull markets create genius.
It’s only fitting. With a multi-decade Credit Bubble having passed a momentous inflection point, there is now mounting concern for GE’s future. Welch’s successor, Jeffrey Immelt, announced in 2015 that GE would largely divest GE Capital assets. These kinds of things rarely work well in reverse. Easy “money” spurs rapid expansions (and regrettable acquisitions), while liquidation phases invariably unfold in much less hospitable backdrops. Immelt’s reputation lies in tatters, and GE today struggles to generate positive earnings and cash-flow.
When markets are booming and cheap Credit remains readily available, Wall Street is content to overlook operating cash flow and balance sheet/capital structure issues. Heck, a ton of money is made lending to, brokering loans for and providing investment banking services to big borrowers. That has been the case for the better part of the past decade (or three). No longer, it appears, as rather suddenly balance sheets and debt matter.
After ending 1994 with Total Liabilities (TL) of $158 billion (total equity $28bn), GE TL closed the nineties at $357 billion. Over the subsequent five boom years, TL increased to $382 billion, $425 billion, $507 billion, $563 billion and then 2004’s $627 billion. TL peaked in Q2 2008 at $720 billion (total equity $127bn). A slimmed down GE ended Q3 2018 with TL of $263 billion supported by $48 billion of Total Equity. GE finished the quarter with Short-Term Debt of $15.2 billion and Long-Term Debt of $100 billion.
GE CDS (Credit default swap) prices surged 24 bps Friday and 86 bps for the week, to 259 bps. This was after beginning 2018 at 41 bps. It’s worth noting that GE CDS closed this week at the highest level since the Fed “exit strategy” mini-panic back in 2011. But rather than commencing an exit from its bloated crisis-era balance sheet, the Fed proceeded over the next three years to double holdings again, to $4.5 TN. This extended GE’s lease on life, along with the fortunes of scores of aggressive borrowers. Perhaps a $9.0 TN Fed balance sheet could save GE.
Most of GE’s long-term debt is rated BBB+, “investment grade” but only a couple notches from high-yield (BB+). The worry is that downgrades will push GE bonds to junk, forcing liquidation by funds and holders restricted to investment-grade holdings. “Moneyness of Risk Assets” has been a key analytical construct throughout this reflationary cycle (an evolution of “Moneyness of Credit” from the mortgage finance Bubble period). Fed (and global central bank) rate, QE, and market backstop policies incentivized (coerced) savers into the risk markets, especially in perceived lower-risk equities and fixed-income. With market yields way below investment return bogeys, many (pensions managers) were compelled to boost returns with leverage. Literally, trillions flowed into perceived safe and liquid “money-like” ETF shares. The flood of “money” into (higher yielding vs. CDs and Treasuries) investment-grade ETF products ensured the easiest Credit Availability imaginable for companies to borrower for capital investment or, more often, stock buybacks and M&A.
November 16 – Bloomberg (Brian Smith and Jeremy Hill): “Investment-grade bond spreads surged to the widest level in two years as a rash of concerns about corporate debt dented investor confidence. The spread on the Bloomberg Barclays U.S. IG Corporate Bond Index widened to 128 bps over Treasuries at the close Thursday, the widest since December 2016. The 6 bps jump was the most since the Brexit vote two years ago. Bond ‘buyers have been relatively indifferent to corporations, and they focused more on rating,’ said David Sherman, president of Cohanzick Management LLC. ‘And now they’re starting to bifurcate the ‘haves’ and the ‘have-nots.””
November 15 – Reuters (Trevor Hunnicutt): “U.S. fund investors are maintaining a wary position when it comes to bonds, pulling more cash after record withdrawals in October, Lipper data showed… Taxable bond mutual funds and exchange-traded funds (ETFs) based in the United States posted $1.2 billion in withdrawals during the week ended Nov. 14, Lipper said. Investors pulled $131 million from municipal bond funds in the eighth straight week of withdrawals for those products. In October, more than $53 billion tumbled out of U.S.-based taxable bond funds, the largest withdrawals on records dating to 1992, according to Lipper.”
Losses are mounting, and liquidity is waning. U.S. corporate Credit is losing its “moneyness,” with profound financial and economic ramifications. The June 2007 subprime eruption marked the inflection point for the “moneyness” of mortgage Credit. The “marginal” borrower/buyer lost access to cheap Credit, commencing a spectacular cycle’s downside. Yet it was when the marketplace questioned the safety and liquidity of previously perceived “moneylike” “AAA” mortgage securities (and the money market borrowings of those heavily leveraged in “AAA”!) that full-fledged crisis took hold.
I remember the argument all too well. “Subprime doesn’t matter.” Arguing that losses would amount to no more than $40 to $50 billion, subprime was viewed by many in late-2007 as almost trivial in comparison to U.S. wealth in the many tens of Trillions. The market in “BBB” corporates has ballooned during this cycle to about $3.0 TN. With the U.S. economy and stock market booming, “BBB” has been viewed as virtually bulletproof. Well into 2008, “AAA” was bulletproof.
With major outflows from investment-grade funds, Credit availability is now tightening for the “marginal” “BBB” Credits. Tighter credit conditions pressure GE and other borrowers that have for years feasted on the loosest finance ever. Heavily levered companies will face higher – in some cases significantly higher – rates when refinancing debt. This should mark a key inflection point for stock buybacks and M&A. These firms will also be vulnerable to the downside of the Credit Cycle, with deteriorating economic prospects and deflating asset prices. Risk is high that huge quantities of “BBB” rated bonds will turn to junk (“fallen angels”). And as one issuer stumbles, a nervous marketplace will fret the next victims of a rapidly tightening marketplace. Contagion at the “Core.” In the event of a major liquidation, who will step up to buy?
November 16 – Fitch Ratings:
