The December Bank for International Settlements (BIS) Quarterly Review made for grim reading; the publication confirmed that the US dollar debt overhang in the EM non-financial corporate sector has left this space highly vulnerable to an accident.
The credit quality of EM borrowers is rapidly deteriorating. The EM private non-financial sector’s debt service ratio (shown as a deviation from its long-term trend) has taken a sharp turn for the worse, surpassing the previous peak during the depths of the Great Recession. Developed economies are on a better footing and have diverged significantly from EMs (i.e. credit quality is improving) especially since 2013.
As our Global Alpha Strategy service highlights in their recent publications, this creditworthiness gap is telling for global cyclicals vs. defensives relative performance. Global cyclicals (energy, industrials & materials) cater mostly to the EMs, whereas global defensives (consumer staples, health care & telecom services) are levered to DMs. As such, the tumbling relative solvency backdrop bodes ill for cyclicals vs. defensives.
See also: BCA: Caution Warranted
Relative sector interest coverage ratios confirm the message from the wide gap between EM and DM debt servicing ratios. Cyclical sector operating income is sinking at a time when rising interest expenses are likely to jump further on the eve of the Fed’s tightening cycle. In contrast, defensives are in a solid position, because profits have stayed resilient. The plummeting relative interest coverage ratio is a harbinger of further losses in the relative share price ratio.
For additional information, please visit the Global Alpha Sector Strategy website at gss.bcaresearch.com.
