When optimism is pervasive, financial observers tend to minimize negative news.
For instance, consider the surge in defaults among private and state-owned firms in China.
Here's what a managing director for a major global financial firm wrote as the author of a March 25 Nikkei Asia article titled "Cheer up China naysayers, bond defaults have benefits too":
While the COVID pandemic raged in the first quarter of last year, there were no defaults. But since late 2020, China has seen a sharp rise in defaults, both among privately owned companies and state-owned entities. Among them are a coal company in Henan Province and a state-owned automotive company in the depressed northeast.
There is now concern that distress among local governments' financial vehicles will begin to spread beyond the most impoverished areas in the country toward more developed provinces such as Yunnan. Indeed, even some university-linked investment entities are expected to suffer defaults from investments in everything from biotech to property with creditors bracing to lose almost all of their money.
As the ratio of corporate debt rises to almost 200% of China's gross domestic product, it is tempting to conclude that the long-anticipated day of reckoning for the country's most leveraged companies is finally approaching.
If true, that is a good thing. While many naysayers on China herald each default as proof of a long-predicted debt crisis, the country's so-called "Lehman moment," it is in fact the opposite -- a sign of recovery and confidence. It is part of China's long-promised move to seek (YES!) quality growth.
"Regulators are now trying to change investors' blind faith in government-affiliated entities," notes one credit analyst. "The default amount could increase as more distressed or zombie state-owned companies are forced to restructure debts."
The number of U.S. defaults started to climb around the same time China's did.
Elliott Wave International's November 2020 Global Market Perspective warned of the dangers of an unconcerned mindset:
[A] reason that complacency toward default risk is dangerous is that bankruptcy filings are surging. The third quarter of 2020 was the worst quarter on record for U.S. bankruptcy filings according to data from Bloomberg. "It wouldn't surprise me if we hit a record for filings this year," said a former bankruptcy judge in an October 6 Bloomberg article. And the consequences of default are becoming worse, as this next headline shows:
Bond Defaults Deliver 99% Losses inNew Era of U.S. Bankruptcies
Desperate to generate higher returns during a decade of rock-bottom rates, money managers bargained away legal protections, accepted ever-widening loopholes, and turned a blind eye to questionable earning projections. Corporations took full advantage and gorged on astronomical amounts of debt that many now cannot repay or refinance.
-- Bloomberg, October 26
In bankruptcy proceedings, creditors now walk away with "just pennies--if that." According to Bloomberg, "the median value for companies' cheapest debt in credit derivatives auctions this year is just 3.5 cents on the dollar, a record low and far below the 23.4 cent median for 2005 through 2019." Lower auction values correlate to lower recoveries by investors. This is all occurring with interest rates at historically low levels. When yields start to rise, increased pressure will be placed on servicing the record levels of outstanding debt. Increasing bankruptcies, debt restructurings and defaults are deflationary.