Higher Leverage Risks

QI TAKEAWAY —  Mismatches between workers and bulging backlogs herald increasing wage pressures at a time when the economy is faced with a stall in private demand. Leverage is the answer in cyclicals most exposed to these cross currents. Active credit investors should be mindful of these factors that suggest a more bearish setting regarding valuation.

  1. Over the last week, IHS Markit has lowered its Q3 GDP estimate (as has the Atlanta Fed), from 3.6% to 1.5%, a far cry from Bloomberg’s 5.0%; driving the downgrade is a stall in private demand, which is working against increasing government spending and inventories
  2. In both the manufacturing and services sectors, the Backlog-Employment Spread, per IHS Markit, is at a historically high z-score; although both are likely to continue seeing wage pressures, the issue is most acute in manufacturing, a function of its innate cyclical nature
  3. The National Association of Credit Management found more firms expanding their credit lines in September in order to stockpile and address supply chain stability concerns; though higher leverage may be needed to weather higher costs, it also creates added right-tail risks