What has become clear following the destruction of government treasuries this past week, besides the fact that we are entering a new era of exponentially higher interest rates that pretty much nobody in the current generation of investors has experience dealing with, is that the equity markets have very little room for error moving forward.
When you have competing government backed assets that are getting close to handing you 4% without a shred of risk barring global thermonuclear war, then equities have to be on their best behavior.
The biggest problem for companies on a more micro level is that there is debt that will have to be refinanced in the years ahead, with an abundance of debt coming due after 2020. What if the yield on the 10 year at that point is above 5%? What will refinancing debt with literally double the level of debt service do to corporate profits? Will growth in profits over the next 18 months be able to mitigate the increased debt servicing costs?
This type of maturity wall into a markedly higher interest rate environment very simply sets up a profit abyss for many companies moving forward. It is becoming more important, as portfolios are balanced and rebalanced in the months ahead, to be cognizant of companies that will be subject adverse conditions of suddenly taking on increased debt service costs at figures that have been completely outside of their ability to forecast.
To simplify this to the maximum degree possible, anything that derives income from yield will do well. Anything that derives income from borrowing will struggle.
Adjust accordingly.
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