Rising default rates and bankruptcy filings show that a “default cycle” has recently begun, lifting concerns of a potential stock market crash to-be. Indeed, according to economists at Apollo Management, the Federal Reserve’s elevated interest rates and high cost of debt have pushed some U.S. companies towards default:
“With the Fed keeping rates higher for longer, higher debt costs will continue to weigh on earnings and interest coverage ratios over the coming quarters, and both [Investment Grade] and [High-Yield] companies will experience higher refinancing costs,” Economists led by Torsten Sløk noted in a credit market outlook published last week.
This will raise financing costs for many companies, inevitably forcing some to renege on their obligations, thus forming the basis for a rise in defaults.
“A default cycle has started with bankruptcy filings rising, and default rates will continue to rise over the coming quarters, impacting in particular middle market companies,” they added.
Not for nothing, by July of this year, 2023 defaults had surged past total 2022 defaults by a staggering 53%, per Moody’s. Similarly, bankruptcy filings through September are up to 516 this year, more than either 2022 or 2021, and on pace to surpass the 518 filings from the first three quarters of 2020, in the heat of the Covid-19 pandemic.
According to Sløk, the Fed’s aggressive rate-hike campaign over the past year and a half or so is the primary culprit behind this year’s surge. Reasonably so, The central bank raised the benchmark rate by more than 500 basis points since March 2022, the fastest increase in rates since the 1980s.
Will Rising Defaults Result in a Stock Market Crash?
Most acknowledge that rising interest rates are slowing economic growth, and it’s also no surprise that corporations, in particular, bear much of that burden. That said, by the overall numbers, the economy has fared much better than many economists had predicted.
Indeed, from the start of the rate-hike cycle, many economists pegged the second half of 2023 as roughly the beginning of a potentially nasty Fed-induced recession. Yet, heading into December, things are, at least on paper, quite good.
Unemployment has continued to hover below 4%; inflation has dropped to just 3.2% annually, with the Consumer Price Index (CPI) reading a 0% monthly change from September to October. Even consumer spending has been shockingly robust, evidenced by last week’s record-breaking Black Friday sales numbers.
That said, the rise in delinquencies may prove an early sign of some internal economic tensions.
“Lagged effects of monetary policy are slowing consumer credit growth with auto and credit card delinquencies rising and bank lending conditions tightening, leading to a significant slowing of loan growth impacting consumers and firms with weak balance sheets,” Sløk noted.
This presents some threat to stocks. As businesses become stretched for cash, especially should consumer spending slow down, earnings will likely suffer. Earnings tend to drive equity markets, meaning this year’s 20% up trend could be subject to a brutal reversal should this year’s default cycle prove more malicious than is currently apparent.
On the date of publication, Shrey Dua did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
