Much corporate debt will need to be refinanced at materially higher levels in the near term, pushing up interest expense and pushing down future profits.
A rebuttal to our concern over the significant buildup of corporate debt is that leverage ratios look reasonable compared to trailing profits. But we don’t think that’s the best way to look at it, particularly late in the business cycle. Recent profits were abnormally high due to COVID stimulus, suppressed interest rates and a boost from economies reopening in the wake of the pandemic, all of which have faded. In our view, what will matter isn’t what leverage ratios are today but what they’ll be when profits are stressed.
In 2006 and 2007, MFS fixed income analysts made sure our equity analysts were incorporating higher borrowing costs and stressing their cash flow models. Those preparations benefited many of our equity strategies versus their benchmarks. While conditions are different today, it’s still probably a good time for investors to stress their models again.
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