I believe that the Fed has repeatedly signaled that they would start raising rates when the real economy gets moving. But the real economy is really one of the last movers in this game isnt it? It is more of a lagging indicator?
The corporations will appear in the earlier innings, and they have. Corporate debt issuance is at an all time high (S&P report), and quality is getting weaker (Moody's report). This drove down WACC and equities have performed tremendously. But, it seems to me that most companies are borrowing, not to fund growth CAPEX investment, but more for working capital requirements, and more importantly, financial engineering such as share repurchasing and M&A.
So basically, companies are getting levered, to get even more levered by buying back shares and doing minimally accretive M&A.
So, the WACC, especially for companies of lower credit, drops exponentially with debt load. This is especially so for lower credit companies with high cost of equity in proportion to cost of debt. They are more sensitive to changes in the capital structure.
So when the Fed raises rate, companies, especially those of lower quality, would suffer, as companies have became largely entrenched into debt rates. As the lower credit companies typically have weak businesses and thus slim margins of the WACC, they would suffer the most as a small rise in rates, would spur a large rise in their WACC, which erodes their margins at an even wider margin. On a market-wide level, WACC rises and the market crashes.
What do you guys think?
