Corporate Health: Signs of Improvement, but Vulnerabilities Remain
The results from our latest quarterly survey of Loomis Sayles’ corporate credit analysts point to some good news. In aggregate, their responses indicated leverage had moved lower, input prices continued their steady march lower, and they felt the risk of a potential crisis had leveled off. While we welcome these developments, we don’t think we have hit bottom in this credit cycle. Our analysts expect further deterioration in three important measures of corporate strength: their credit outlook, profit margins and pricing power. The bottom line: we believe companies are likely to experience more pain in the months to come.
Easing inflation feeding through to lower costs
On the positive side, we want to highlight the continued decline in input costs. Costs have been trending lower for several quarters—the CANDIs’ most recent reading showed a particularly steep drop from six months ago— as global supply chains have returned to pre-pandemic norms. Our findings square with recent inflation data, which showed prices easing at both the consumer and producer level. Inflation readings remain well above the Federal Reserve’s two percent target.
Leverage, the ratio of debt to profits, has not reached concerning levels in this cycle in our view. In most industries, our analysts felt the risk of a potential crisis had largely stabilized at a benign level.
Key metrics hint at further erosion
On the opposite side of the ledger, profit margins for the S&P 500 Index have fallen about 4.7% from their peak six quarters ago.i[i] The table below shows how profit margins tend to peak about one year before a recession hits.