Credit ratings in expansions affect companies like Thermo Fisher

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Nov. 26 2019, Updated 5:10 p.m. ET

Economic expansion

According to the National Bureau of Economic Research (or NBER), the trough of the recession was reached in June 2009, and the economy began expanding in Q3 2009. The number of high-yield corporate bond (HYG) ratings downgrades by credit ratings agency Standard & Poor’s were at the highest during the recession in Q1 2009, at 323. The up/down ratio for high-yielding corporate bonds was also at its lowest in Q1 2009, at 0.1. Since Q2 2009, the up/down ratio for high-yielding corporate bonds started to increase. The average up/down ratio for high-yielding corporate bond (JNK) ratings increased from 0.25 in 2008 to 0.34 in 2009.

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The graph above shows how debt securities of different credit qualities have mirrored the growth rate in real GDP. The up/down ratio for all companies in the S&P 500 Index (SPY) bottomed in Q1 2009, coming in at 0.11. The 8.3% contraction in Q4 2008 GDP was the lowest from 2007 to 2013. This is because the up/down ratio for corporate debt ratings is usually seen as a lagging indicator, which follows cues from economic activity. It usually follows expansion or contraction in the economy by correspondingly increasing or decreasing.

After growing to 1.49 in 2013 from 0.29 in 2009, the up/down ratio for all corporates in the S&P 500 Index (SPY) has dropped to 1.36 in 2014 year-to-date. Strangely enough, the overall ratio of debt upgrades to downgrades at 1.36, has remained the same in the first quarter of 2014 (year-to-date) compared to Q1 2013. However, seasonally adjusted quarter-on-quarter GDP growth was just 1.1% in Q1 2013, which was also the lowest among all four quarters in 2013. In Q4 2013, real seasonally adjusted quarter-on-quarter GDP grew 3.2%.

However, in the current environment, GDP increases or decreases may not necessarily translate to a higher or lower up/down ratio in Q1 2014, as credit rating agencies (or CRAs) have voiced concerns about increasing amounts of leverage assumed by companies (LQD) for non-investment purposes, like funding share-buybacks, in order to increase the return on equity to shareholders.

To read about how corporates like Berkshire Hathaway (BRK-B) have taken advantage of low interest rates to increase returns to shareholders, read on to Part 4 of this series

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