The financial crisis really freaked out a lot of CFOs.
During the darkest days of the crisis, the credit markets froze. Liquidity in the debt markets dried up and interest rates exploded. It was so bad, even the most credit-worthy companies struggled to secure the financing they needed to run their day-to-day operations.
So for years, companies have been delevering their balance sheets. In other words, they have been cutting back on debt.
And seven years after the crisis, there’s not much evidence to suggest that the big companies have are back to boosting debt as a percentage of their balance sheets.
“Leverage, as measured by debt in relation to book equity, has fallen dramatically and now stands at the lowest level since the late 1980s,” Barclays’ Jonathan Glionna wrote in April 22 note to clients. “After increasing steadily from the mid-1980s until 2007, leverage has now declined seven years in a row.
“This is a unique occurrence,” he continued. “Based on our 42 years of data, leverage had never before fallen more than three years in a row, let alone seven. What began as a reaction to the credit crisis has turned into a secular trend, with implications for stock prices.”
Believe it or not, this is not something investors should be celebrating as it depresses return on equity. (You can read all about why that occurs here.) And not only is it theoretically bad for ROE, Glionna’s research shows that companies with low leverage are laggards in the market.
“Our factor analysis shows that non-financial companies with high debt-to-equity have consistently outperformed over the past 15 years,” Glionna wrote. “In addition, companies that are increasing their debt-to-equity ratio have outperformed. In other words, the market rewards high and increasing leverage.”
Glionna has a 2,100 year end target for the S&P 500.