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Global debt surges — investors take note as governments and corporations take advantage of cheap money

 

  • Global debt surged to a record $250.9tn in 1H 2019.
  • The move shows total global borrowing increasing by more than 3% in just six months.
  • A report released on Thursday by the International Institute of Finance (IIF) suggests there is little sign of a slowdown in the rate of increase.
  • Some stocks still shun corporate debt. No-debt and low-debt stocks such as Align Technologies (NASDAQ:ALGN) have taken a different path — one that should benefit it, if or when the global debt train hits the buffers.

 

Global debt surged by $7.5tn in the first half of 2019. A report released by the IIF calculates the current total to be $250.9tn at the end of this period, which is a 3.08% increase from the figure at the turn of the year. Its prediction is for further increased borrowing. The report suggests that by the end of 2019, the total will exceed $255tn and show an annual increase in the region of 5%.

Source: CNBC

Those struggling to get to grips with the size of the borrowing can move away from considering what a trillion dollars looks like and instead work with the smaller numbers. The total amount of borrowing is expanding by almost 5%, whilst by comparison, the US and Japan have forecast annual GDP growth rates of only 2% and 1.3% respectively (Source: Trading Economics)

The report notes that it is both corporates and governments that are driving the demand and turning it into a long term trend — one that is gaining rather than losing momentum.

“The big increase in global debt over the past decade — over $70 trillion — has been driven mainly by governments and the non-financial corporate sector (each up by some $27 trillion). For mature markets, the rise has mainly been in general government debt (up $17 trillion to over $52 trillion). However, for emerging markets the bulk of the rise has been in non-financial corporate debt (up $20 trillion to over $30 trillion).”

Source: CNBC

 

Free money

The increased debt levels have been spurred on by falling global interest rates, which in many of the world's economies are sitting at record-low levels. With some central banks, such as those in Switzerland and the eurozone setting negative rates, some investors — such as those buying German government bonds — are paying for the privilege of lending to the German government. Given the topsy-turvy nature of the situation, it's surprising that governments have resisted the temptation to take advantage of ‘free money’ for so long. The recent report suggests that reticence relating to borrowing has been well and truly overcome through 2019, particularly in the US and China.

Source: McKinsey & Company

The German government remains something of an exemption, but is increasingly subject to sniping from other agents (including the European Central Bank), which are trying to encourage the Bundesbank to borrow to spend.

Source: International Monetary Fund

Corporations have also been taking their debt to record levels. This part of the debt boom is particularly concerning for some market analysts — some of whom see corporate debt as being the next breaking point for the global economy. The risks associated with corporate debt are considerable and go some way to explaining why investors have been willing to take the hit associated with lending to nation-states that are perceived to be more trustworthy.

 

Firms with low and no-debt

The pros and cons of a corporation being debt-free depend largely on investor risk appetite. Investors with a higher propensity for risk suggest that any company that is not leveraged in some way may not be open to expanding its business to take advantage of new opportunities. Apple (AAPL) and Microsoft (MSFT) are two high-profile companies that were debt-free for a considerable period of time but moved towards taking on loans to grow their businesses. In truth, they fall into a sub-set of companies that have low amounts of debt and cash balances on-hand to cover the debt should that be required.

The argument in favour of ‘sustainable' debt levels tends to build during times such as now when rates are low. The other side of the coin is that debt-free companies are some of the safest for investors. There is obviously zero risk of default, but the absence of debt payments also improves cash flow.

Investors with lower risk tolerance may find themselves attracted to firms with lower debt or no debt. Should the global economy slow down and interest rates rise, low-debt and no-debt stocks may be in a better position, but they will not be immune from the fallout. Not only could business slow down, but there could also be increased exposure to greater counterparty risk. There is nothing to suggest their trading partners might not turn out to be bad debtors.

 

Align

Align Technology (NASDAQ:ALGN) is a debt-free company. The firm's Invisalign product holds a near-monopoly in the non-metal-brace dental market. Whilst investors in the stock do need to strap on their seat-belts for a bumpy ride, the stock has, over a five-year period, outperformed both the S&P 500 and Nasdaq indices.

Align Technologies — (Nasdaq: ALGN) — five-year price chart:

Source: TradingView

Align Technologies — (Nasdaq: ALGN) — five-year price chart — descending wedge:

Source: TradingView

The recent share price strength comes off the back of the firm's earnings update of Wednesday, 23rd October. The medical equipment provider reported $1.28 earnings per share (EPS) for the quarter, topping analyst estimates of $1.14.

The historical debt chart shows an absence of debt. Simply Wall St describes the firm’s balance sheet at “flawless” (Source: Simply Wall St).

Source: Simply Wall St

On a five-year perspective, Align Technologies’ stock price is forming a descending wedge pattern with price. Price is currently at a possible, but as yet unconfirmed, break to the upside. The short-term RSI is showing signs of the stock being overbought. The 14-day Relative Strength Index (RSI) is at 76.89. The real advantage for holders of ALGN would be if the market moves against firms with corporate debt and rotates into those that are debt-free.