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Unintended consequence of ultra- low interest rates

December 1, 2017 | Commentary

  • The long economic recovery since the financial crisis has not uniformly lifted all corporate boats. A historically high percentage of small cap public companies are not profitable and have not been for many years.
  • The policy of near-zero short-term rates in the United States, Japan and Western Europe has distorted yield curves around the globe. Unsurprisingly, many corporations have taken advantage of this and added to their debt burdens.
  • Not all of these companies have great business models or prospects, but the availability of easy credit has allowed these companies a much longer runway toward hoped-for success. In some cases this just delays the inevitable failure.
  • As interest rates rise, some of these companies will be unable to sustain their losses and will fail. This will have two major implications. It will likely usher in opportunities for a new profitable distressed debt cycle. It should also prove to be fertile ground for active equity managers versus passive investing where all names are purchased indiscriminately according to their current market weights.
  • None of these risks would appear imminent. Economies around the developed world are expanding in a coordinated fashion for the first time in over a decade. Central banks are still accommodating and as a result liquidity is plentiful. The table is getting set, however, for the next cycle and each of these trends warrants close scrutiny.

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