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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
Forecasting is a risky endeavour. As the old joke goes, the stock market has predicted nine of the past five recessions. The count rose to 10 last year as interest rates jumped and stock prices fell. The all-important US yield curve, the spread between short- and long-dated debt, turned negative. Usually that signals a recession. Yet the US economy is expanding and stock prices are up this year.
Pandemic-driven changes in behaviour may explain why. Lockdowns were accompanied by ultra-low interest rates and fiscal expansion. Households amassed savings. JPMorgan thinks these are only just being used up. Many businesses took advantage of excess liquidity to load up on cheap debt. All this postponed recession, despite a very negative yield curve.
Meanwhile, average operating profit margins for S&P 500 companies of 10 per cent remain near record highs, according to Yardeni Research. The forward earnings multiple has, however, edged down from 21 times earlier this year to 17.5 times.
Large companies with access to bond markets have in effect played the yield curve in reverse, says Société Générale strategist Albert Edwards. They borrowed at low, fixed rates and reaped the reward of rising deposit rates. In the US, he estimates that this has added 5 per cent to market profits over the past year. Typically, companies could expect a 10 per cent deduction.
However, aggregate figures mask a coming reckoning. Benefits are largely accrued by the biggest companies. Effective interest rates have barely budged for the top one-tenth of the broader S&P 1500 index over the past two years. For smaller companies, borrowing rates have tracked market rates higher, putting downward pressure on earnings.
Signs of weakness are emerging. Total US business bankruptcies of 37,327 in September were 12 per cent higher than in 2022 as the jobs market slows and credit for smaller companies grows tighter. That makes stocks that have recovered much of last year’s losses pricier still.
