`Grotesque' Leverage, Rising Rates Causing Damage, SocGen Says

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(Bloomberg) -- The fear over 10-year U.S. Treasury yields breaking through 3 percent has been a long time coming, according to Societe Generale SA.

“Interest rates are already doing damage, people just haven’t noticed,” Andrew Lapthorne, the firm’s global head of quantitative strategy, said in an interview Tuesday. “Leverage in the U.S. is grotesque for this stage of the cycle. At the moment you’ve got peak leverage at peak prices. It’s not like you have to dig deep to find a problem.”

The number-one conversation Societe Generale’s having with clients right now is about the correlation between bonds and equities. But risks to corporate balance sheets is a bigger problem at the moment, particularly in the U.S. and China. Lapthorne said he worries about volatility in debt because of the impact it can have on the economy, particularly how it weighs on businesses and the job market.

Credit markets may get choppier due to triggers like high-profile bankruptcies, such as Toys ‘R’ Us, or if corporate buybacks drop, Lapthorne said. While Credit Suisse anticipates fewer share repurchases this year, they’re an outlier. JPMorgan Chase & Co. estimates they’ll rise to a record $800 billion from $530 billion last year. Bank of America Corp. said if the current pace continues there may be as much as $850 billion in 2018, while Goldman Sachs Group Inc. sees buybacks becoming “less constructive” in 2019.

READ: A $3 trillion credit market has corporate bond investors on edge

Either way, Lapthorne doesn’t see buybacks as a panacea for markets. He said companies that announce them but don’t follow through outperform those that do. The average loss from share repurchases is about 5 percent, Lapthorne estimates. To him, the action of borrowing money to get a short-term boost in earnings-per-share is often motivated by executive compensation in the U.S.

“The performance differentiator in the U.S. stock market has been an aversion to buying companies with bad balance sheets,” Lapthorne said. This has been fueled by concerns about the Federal Reserve and its rate-hike path, he added.

He has further concerns about the direction of the markets as well.

“Instead of the usual market driver of economic growth, this bull market has been driven by valuation growth,” Lapthorne said, adding that confidence in asset prices is deteriorating as volatility has risen.

©2018 Bloomberg L.P.

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